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Leverage Works

What is leverage?

Leverage is a financial instrument that magnifies the purchasing power of a trader. For example, if you have $400 in your account, with a leverage of 100:1 you can purchase up to 40,000 Euro.

Why do you need leverage?

Prices on many financial instruments, including currencies, fluctuate every minute, sometimes even every second. However, often times such fluctuations are minuscule and its relatively rare for currency prices to make significant jumps or falls. This does not mean that you cannot speculate. Since leverage magnifies your purchasing power, it also magnifies profit and risk potential.

Is trading with leverage risky?

The more leverage you use, the more risk you take on. We recommend trading with a leverage of 20:1 and recommend using a higher leverage only if it is a part of your overall trading strategy or your trading system.

Financial leverage

Financial leverage (FL) takes the form of a loan or other borrowings (debt), the proceeds of which are reinvested with the intent to earn a greater rate of return than the cost of interest. If the firm's rate of return on assets (ROA) is higher than the rate of interest on the loan, then its return on equity (ROE) will be higher than if it did not borrow. On the other hand, if the firm's ROA is lower than the interest rate, then its ROE will be lower than if it did not borrow. Leverage allows greater potential returns to the investor than otherwise would have been available. The potential for loss is also greater, because if the investment becomes worthless, the loan principal and all accrued interest on the loan still need to be repaid.

Margin buying is a common way of utilizing the concept of leverage in investing . An unlevered firm can be seen as an all-equity firm, whereas a levered firm is made up of ownership equity and debt . A firm's debt to equity ratio (measured at market value or book value , depending on the purpose of the analysis) is therefore an indication of its leverage. This debt to equity ratio's influence on the value of a firm is described in the Modigliani-Miller theorem . As is true of operating leverage , degree of financial leverage measures the effect of a change in one variable on another variable. Degree of financial leverage (DFL) may be defined as the percentage change in earnings ( Earnings per share ) that occurs as a result of a percentage change in earnings before interest and taxes.