Leverage is the practice of using borrowed capital to increase the potential return of an investment.
Understanding leverage in finance
When an investor uses leverage, they are trading with more money than they hold in their account. This involves borrowing funds from a financial institution to open a larger position in an asset such as a stock or a commodity. The objective is to increase the profit if the market price moves in a favorable direction.
Leverage magnifies losses exactly as it magnifies gains. If the asset loses value, the investor remains responsible for repaying the borrowed amount alongside any interest. A small drop in the market price can deplete the initial capital completely. When this happens, a broker may issue a margin call requiring the investor to deposit more money to keep the trade active.
Financial authorities implement different leverage limits depending on the region. Regulators in the European Union strictly limit retail trading leverage to protect consumers. Jurisdictions in parts of Asia or the Caribbean often permit higher borrowing limits. Institutional investors generally operate under different regulatory frameworks and access higher limits than retail participants.
Example
Suppose an Elephant decides to trade peanut futures. You have $1,000 in your trading account and your broker offers 10:1 leverage. This allows you to control a $10,000 position using your $1,000 deposit. The broker supplies the remaining $9,000.
If the price of peanut futures goes up by 10 percent, the position value reaches $11,000. You close the trade and return the $9,000 to the broker. This leaves you with $2,000. Your initial $1,000 grew by 100 percent.
If the price drops by 10 percent, the position value falls to $9,000. The broker takes back their $9,000 to cover the loan. Your $1,000 deposit is entirely gone due to a 10 percent market decline.