What is Leverage?

In simple terms, Leverage is like a "lever" that allows investors to control larger amounts of money with a smaller capital by using borrowed funds.
It enables investors to make bigger investments than their actual capital, potentially amplifying profits.
However, it's important to remember that leverage can also magnify losses, so it must be used carefully.
Leverage is commonly used in stock margin trading, futures & options, real estate investments, and various financial markets.

 

📌 How Does Leverage Work?

The core concept of leverage is using margin to execute larger transactions.
Let’s look at some practical examples:

🔹 Leverage in Margin Trading

• For instance, if you have $5,000, you can borrow an additional $10,000 from your brokerage to purchase $15,000 worth of stocks.
• This allows you to control more assets than your initial capital.
• However, while your potential gains double, so do your potential losses.

🔹 Leverage in Futures & Options Trading

• In futures and options trading, you only need to deposit a small margin to control a much larger contract.
• For example, if you want to trade a KOSPI200 futures contract worth $100,000, you might only need to deposit $15,000 as a margin.
• If the price rises, your returns can be substantial, but if it falls, your losses can be just as large.

🔹 Leverage in ETFs

• Leveraged ETFs aim to amplify the returns of the underlying index.
• For example, if you invest in a 2x leveraged KOSPI200 ETF and the index goes up by 1%, your return will be 2%.
• Conversely, if the index drops by 1%, your loss will be 2%.

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📌 Examples to Understand Better

🔹 Example of Margin Trading

• Let’s say you have $10,000 and use 2x leverage to buy $20,000 worth of stocks.
• If the stock price increases by 10%, you would earn $2,000, resulting in a 20% return on your initial capital.
• However, if the stock price drops by 10%, you would lose $2,000, which is a 20% loss of your original investment.

🔹 Example of Futures Trading

• Investor A decides to trade a KOSPI200 futures contract worth $100,000.
• The initial margin requirement is only 10%, meaning they only need to deposit $10,000.
• If the market price increases by 5%, they gain $5,000.
• On the flip side, if it falls by 5%, they lose $5,000.

Leverage allows you to trade with more money than you actually have, which is exciting, but it also means that your losses can be magnified.

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📌 Why is Leverage Important?

✅ 1. Higher Returns with Less Capital

• Leverage allows investors to maximize their returns even with a smaller initial investment.
• For example, $10,000 with 2x leverage effectively acts like $20,000 in the market.

✅ 2. Versatility Across Financial Products

• Leverage is applicable in various markets such as stocks, futures, options, and ETFs.
• This flexibility makes it a popular choice for experienced investors.

✅ 3. Amplified Risks

• While the potential for profit increases, the risk of loss also multiplies.
• If the market moves against your position, your losses can exceed your initial investment.

✅ 4. Margin Call Risk

• If your investment loses value and your margin drops below the required level, the brokerage may issue a margin call.
• This requires you to deposit additional funds to maintain your position.
• If you cannot meet the margin call, your assets might be liquidated automatically to cover the losses.

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📌 Conclusion

Leverage is indeed a powerful tool in investing.
It allows you to amplify your profits with a smaller amount of money, but it also magnifies your risks.
Understanding the risks and practicing proper risk management are crucial when using leverage.