Leverage is a financial tool used to increase the purchasing power of an investor or company by using borrowed money or available assets to generate higher returns. The idea is based on taking advantage of borrowing or derivatives to achieve a multiplier effect on investments.
Types of leverage:
1. Leverage in trading:
Used in financial markets (such as forex, stocks, and futures).
Allows the trader to control a trade larger than his available capital.
Example: If the leverage is 1:100, you only need 1% of the trade value as collateral (margin).
2. Leverage in Business:
Companies use loans to finance their projects in order to increase their return on capital.
For example, a company may borrow money to purchase assets or finance expansion.
Benefits of leverage:
Increased potential returns: You can make more profits with a relatively small amount.
Business Expansion: Enables companies to expand their operations without the need for full capital.
Leverage Risks:
Potential Losses Increase: Just as profits are magnified, losses are magnified in the same way.
Increased liabilities: Excessive borrowing increases financial burdens if the investment fails.
Market Volatility: As leverage increases, the portfolio becomes more susceptible to volatility.
Tips for using leverage with caution:
1. Do not use high leverage unless you are prepared to take the risks.
2. Understand the market well and rely on risk management strategies.
3. Monitor your debt-to-equity ratio to avoid over-borrowing.
4. Use Stop Loss orders in trading to reduce risks.
Leverage is a powerful tool, but its successful use depends on good planning and careful risk management.