Leverage: a basic concept in trading

Leverage can be defined as a type of operating facility offered by a broker (or financial intermediary) to an investor which allows him/her to take positions bigger than the amount of requisite funding. This gives the investor greater exposure to the market, paying down only a part of the total value of the position. In other words, trading with leverage means operating with more money than is really available.

There is a number of important terms that any trading investor using leverage should know:

• Margin: the amount required by a financial intermediary to cover possible losses. Margins are usually expressed as a percentage of the value of the position.
• Invested capital: the total amount of the operation
• Capital at risk: the amounts of funds in the investor’s account at potential risk in the operation.
• Stop-loss: with the aim of limiting the capital at risk, the investor needs to define and apply stop-losses; that is, the price levels at which a position is automatically unwound in order to limit losses.

Advantages and risks in leverage

Investors who want to increase their position in the markets use leverage. This provides investors with a series of significant advantages.

Firstly, it provides investors with more capital in that the amount staked is only a fraction of the value of targeted assets; that is, the investor only has to pay a part of the total position. If this mechanism is used effectively, the investors can obtain a greater return that would be in the case of a direct stake. Also, if the investor diversifies his/her asset portfolio, he reduces non-systematic risk.

However, these operations entail risks, which makes it essential to constantly check and handle one’s position. When taking a leveraged position the investor first has to check whether the cost of debt is below the possible return that can be obtained. An investor should never take a leveraged position if he/she has insufficient capital to cover any possible loss.

Although greater exposure can work out to your advantage, it can work against the investors and multiple his/her losses. If the market moves in a different direction to what is desired, it is possible to lose more than initially invested and even involve getting into debt.

The key lies in managing the amount of debt taken on in the best way. To do so you have to know the product well and be able to predict the possible direction it takes in the future. If an investor wants to make a successful investment using leverage, he/she must take decisions based for example on the cost of debt, the level of leverage and aversion to risk.

This is only one of the concepts dealt with in the BBVA Trader platform which has an extensive list of tutorials including an explanation of investment strategies using warrants and technical analysis identifying patterns that point to a change in trend. It also offers manuals, courses on understanding, using tools such as BBVA Trader Pro and simple guides on other types of operations. BBVA also organizes events that familiarize those interested with the trading world in a simple and clear fashion.