August 24 - Jitan Solanki
Discover the best markets and strategies to invest in during risky times.
A good analogy for leverage trading would be this: Remember when you were a kid and you tried to fry ants under a magnifying glass? (Well, if you were as terribly wicked as I was as a child.)
The glass was enabling you to increase the heat of the sun and concentrate the sun’s rays on a very small area, so that you could become the neighbourhood’s tiniest arsonist.
Similarly, traders use leverage to magnify their returns. Leverage trading allows them to increase the size of their trades using a relatively small amount of money. It’s one of the main advantages of CFD trading – it makes the markets more accessible to the average person who doesn’t have a ton of spare cash lying around.
Where those damn profits?!
Leverage is usually expressed as a ratio. So if your leverage is 5:1, that means you can open and control a $5,000 trade with just $1,000 in your account (typically called the “margin”). The balance comes from a kind of loan that’s provided by your broker. They get paid a commission based on the size of the larger position, so it’s a win-win!
As we just explained, leverage allows people to make large trades without having to put down too much of their own money.
But what if you’re flush with cash? Why wouldn’t you just invest your own money rather than ‘borrowing’ from the broker?
Well, there are three perks that come with leverage trading:
3. You can use leverage trading to turn small price changes into big results. For example, you already know that exchange rates go up and down every damn day. However, the differences can be pretty small, like mere fractions of a cent. This is why leverage trading is very popular with forex traders – they can turn these micro-fluctuations in exchange rates between two countries into potentially huge gains. In some ways, it’s like the Viagra of trading…
Leverage trading can be just like Autocorrect – while it can work for you, it can also work against you.
Didn’t see that one coming
If leverage trading can be used to magnify profits, be aware that it can also magnify losses. Going back to that Heineken example: If you had been wrong about its share price going up after its earnings announcement. Instead, the stock took a 5% dive – you would’ve lost your £50. But if you had opened that position with a 5:1 leverage, your loss would now amount to £250.
This is why the excessive leverage can be super risky. There are some brokers out there offering 1,000:1 leverage trading! You can end up losing a lot of money very quickly, so start small and get some experience before you crank that thing up.
With BUX, you can never lose more money than you put in. So if you invest £1,000 in Heineken in our app, using 5x leverage, it’s like you invested £5,000. But even if Heineken’s share price goes tits up, you can only lose a maximum of £1,000. Why? Because your trade is automatically closed when it falls below the actual amount of cash you put in.
So BUX gives you the opportunity to increase the value of your trade without ever running the risk of losing more than your initial investment. Sweet, right? Get to know more about leverage trading with our award-winning app.
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There's a way to see just how well your investment is being spent and it's called the dividend payout ratio. Before you think this will be as difficult as learning to speak Latin, fear not because we break down what the dividend payout ratio is and how you can calculate it - even if you failed math in school!