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Only a small down payment is required to open a position in the market when using a leveraged account. The amount of capital required to be deposited into your account is known as “margin.” The remaining capital required to maintain the market position is essentially loaned to you by the broker.
Leverage allows you to control a larger market position than you normally would be able to with your available trading capital. For instance, let us say you intend to purchase 100 shares of a certain company’s stock that is currently valued at $10 per share. You would need $1,000 worth of capital with a traditional broker. If the stock value increases to $12, your market position will have a value of $1,200, which is a 20% gain. On the other hand, if the market depreciates to $8 per share, the value of your investment would be $800 which is a 20% loss.
Alternatively, let us say that your broker is providing a leveraged account with a required margin of 10%. In this case, you would have only needed $100 in capital to open a market position of 100 shares. In the case of the market appreciating to $12 per share, you would gain the same $200, meaning 200%, more than your initial investment. On the other hand, if the market goes down to $8 per share, you will lose $200 which is twice your initial invested capital.
With all of this in mind, leverage gives you a higher potential for larger profits, but it also comes with heightened risks of big losses. Therefore, you should always keep this risk in mind when deciding to trade on a leveraged account. Make sure to adjust leveraged position sizes in order to meet your own risk tolerance.