Leverage

Leverage is a mechanism that allows a trader to open positions significantly larger than their actual account balance by borrowing the difference from the brokerage firm. Leverage is typically expressed as a ratio, such as 1:100 or 1:500, indicating how much trade volume can be controlled for every unit of capital.

For illustration, a 1:100 leverage ratio means that every $1 in a trader's account can control a $100 position in the market. This gives traders with limited capital the opportunity to participate in larger trades than their immediate financial resources would otherwise allow.

Leverage is closely linked to the concept of margin; the higher the leverage ratio, the lower the margin required to open a position, which increases the trader's capacity to hold multiple positions simultaneously.

While leverage magnifies potential profits when the market moves in the trader's favor, it equally magnifies potential losses when the market moves in the opposite direction, making it a double-edged sword that requires rigorous risk management.

A common mistake is using the maximum available leverage without a sufficient understanding of its impact on risk exposure, which can deplete capital very quickly during unexpected price movements.