Leverage in the financial market - a powerful tool full of risks

For those new to the world of investing, the term leverage (Leverage) may be frequently discussed across various trading channels, whether in the Forex market, cryptocurrency markets, or trading other assets such as gold and oil. However, before taking any action, the most important thing is to thoroughly understand how to use leverage correctly.

What is leverage and why is it important to understand this?

leverage (Leverage) is a financial strategy that allows investors to access investment positions larger than their actual capital by borrowing money from a broker. The ability to control larger positions is a key feature of leverage.

The crucial point to remember is that leverage has two sides — one can significantly amplify profits, but it can also increase the risk of losses. If the investment moves in the opposite direction of your prediction, losses can exceed your initial capital.

Risks behind Leverage - What investors need to watch out for

Before jumping into leverage recklessly, consider the various risks involved:

Rapid Losses

Due to the magnifying effect of leverage, even small price movements can lead to huge losses. For example, if you use 100x leverage, a 1% price movement will impact your portfolio by 100%.

Margin Call - The demand for additional funds

When the value of your position drops to a certain level, the broker will send a “Margin Call” notification, indicating that you need to add funds to your account. If you do not, your position will be automatically closed, resulting in missed recovery opportunities.

Unexpected Volatility

Financial markets are highly volatile, especially during major news events or economic downturns. Leverage greatly increases the risk associated with this volatility.

Psychological Risks

Using high leverage creates stress and mental pressure, which can lead your decisions to be driven more by emotions than by rational analysis.

Examples of the differences in using leverage

Scenario 1: Buying Bitcoin without leverage

Suppose you have $1,000 and buy Bitcoin at $50,000 per coin. If the price of Bitcoin rises to $55,000 (a 10% increase), you will make only $100 profit.

Scenario 2: Buying Bitcoin with 10x leverage

Your $1,000 acts as collateral. With 10x leverage, you can control a position of $10,000. When the price of Bitcoin rises to $55,000, your profit becomes $1,000 (a 100% increase).

But — and here’s the key point:

If the price of Bitcoin drops to $45,000 instead (a 10% decrease), you will lose the entire $1,000, which means complete loss of your capital.

When does leverage benefit you?

Although leverage carries high risks, it also offers several advantages when used appropriately:

1. Increased profit potential

When your predictions are correct, leverage can significantly amplify your gains. This is a primary reason many investors are interested in using leverage.

2. Efficient capital utilization

Leverage allows you to access multiple investment opportunities with less capital, making cash flow management more efficient.

3. Flexibility in strategies

Leverage opens up the possibility to try various investment strategies without needing to invest large amounts of money.

The difference between Margin and Leverage - Don’t confuse them

Many people often confuse these two terms. Let’s clarify the difference:

Margin (Margin) is the amount of money you deposit as collateral, expressed as a percentage (such as 1%, 5%, 10%). For example, if the margin is 1%, you need to deposit $1,000 to control a position of $100,000.

Leverage (Leverage) is the tool that uses this collateral to magnify the size of your position, expressed as a ratio (such as 1:50, 1:100, 1:200). For example, 1:100 leverage means that $1,000 can control a $100,000 position.

The relationship between the two is that margin determines the minimum amount needed, while leverage is the power to expand that amount.

Example of gold trading with leverage

Some investors use leverage to trade gold. Suppose you believe gold will rise from $1,530 per ounce. You decide to open a larger position using leverage.

If you invest $1,000 without leverage, your profit will be only $20 (when the price increases by 1%).

But with 100x leverage, the profit becomes $2,000 from the same price change — a 100-fold increase.

Safe leverage strategies for beginners

If you are new to investing, consider these points seriously:

Start with low leverage

Don’t obsess over using 500x leverage. Start with ratios like 4:1 or 5:1, giving yourself time to learn and adapt.

Strict risk management

Set stop-loss orders to limit maximum losses. Define the percentage of your capital you are willing to lose on each trade.

Don’t trade based on emotions

The stress from leverage often leads to emotional decisions, which are the biggest enemies of investors.

Understand that even if you are right 99 times, one mistake can wipe you out

Lack of discipline in this regard causes many investors to lose money. The most important thing is to preserve your capital before thinking about making profits.

Summary

Leverage is a powerful financial tool for those with sufficient knowledge and understanding, but it also comes with a structure of risks that must be respected. The decision to use leverage should be based on careful analysis, not wishful thinking. Meanwhile, continuous learning and improving risk management skills are key to maximizing leverage benefits sustainably in the financial markets.