When an investment opportunity appears and you are short on capital, how do you take advantage of it? This is when financial leverage becomes an important tool, helping investors use their limited capital to capture investment opportunities.
1. What is financial leverage?
Financial leverage is a powerful tool that helps investors take advantage of capital to seize investment opportunities, to increase profit rates by expecting that future asset values ââwill exceed borrowing costs, bringing profits. higher benefit.
Using financial leverage allows you to gain potential profits from the entire trade with just a fraction of your own money. The loan amount can come from banks or financial institutions.
To understand what financial leverage is, look at the following example:
Mr. A buys an apartment B under construction with a total payment of 2 billion VND. However, he only had capital of 500 million, Mr. A borrowed the remaining 1.5 billion from the bank. After 1 year of completion, Mr. A offered to sell it for 2 billion 5. After that, A soon had someone agree to buy it back.
Minus the bank loan amount of 1 billion 650 million (150 million interest/year) + 500 million initial capital. A earned 350 million in profit after 1 year of investment.
Using financial leverage effectively will bring enormous benefits. However, there are also many potential risks if not careful when using it. In the above example, in the bad case, Mr. A cannot sell the house so he will have to bear the loan amount of 1.5 billion along with interest. Monthly.
2. What is the role of financial leverage?
Although it carries many potential risks, financial leverage is still the preferred financial tool of businesses and investors.
Financial leverage allows an investor or business to leverage borrowed money to generate higher returns from a specific investment or business.
Through financial leverage, one can invest or purchase assets with a small portion of their capital and use borrowed money to supplement that amount.
When assets increase in value or businesses achieve profits, investors' benefits will be calculated based on the total asset value or profits instead of just the amount they invested.
Thus financial leverage has the following roles:
Capital optimization: Financial leverage allows businesses to compensate for capital shortages to maintain business operations. For retail investors, they can take advantage of small capital to earn high profits.
Increase Profits: Financial leverage is an effective tool in boosting profits. If used intelligently and combined with thorough analysis, it can yield higher profits. But it should be noted that using leverage also comes with risks, so it needs to be managed carefully.
Tax incentives: Loans as well as interest will be included in business expenses. When finalizing taxes, this amount will be deducted from taxable income. This helps businesses minimize taxes and increase net profits.
3. When should you use financial leverage?
Before thinking about using financial leverage, you need to firmly grasp the following personal financial management formula: Reduce expenses, increase income, investment, leverage.
You need to follow the above order to avoid falling into financial traps. Most teachers outside the market advise you to do the opposite of the above order, even if you have to pay a lot of money for their courses, to Then you get into debt because you followed their financial advice.
In 2021 and 2022, the real estate fever in Vietnam will increase, from urban to rural areas, there will be land for sale signs everywhere. Courses to get rich and invest in real estate are also springing up, these teachers always teach the crowd that "You must know how to take advantage of bank leverage" and you look at the past 2023, bank interest rates increased, real estate Assets were frozen, and as a result, many people had their assets confiscated and went bankrupt.
Once you have mastered your cash flow, controlled your inflows and outflows, and mastered your investment skills, then you can use financial leverage to increase your assets smartly, without pressure. from interest rates.
4. Use financial leverage in Crypto
4.1. What is Margin?
In the Crypto market, Margin or margin trading is a form of using financial leverage.
Margin has a few related terms as follows:
Margin:Â The amount of money you use to buy an investment
Leverage: Using leverage is when you increase your investment amount. For example, investing $1000 with x100 leverage means you are investing $100,000.
Volume: is the product of (Margin) x (Leverage).
Position: That is, the position includes Long (buying) and Short (selling).
Liquidation:Â This is the liquidation price. For example, you bet on Bitcoin margin. When the BTC price surpasses the liquidation price, your entire investment will be gone.
For example:Â You have $10,000. ETH price is currently at $1,000 and IÂ predict ETH will rise to $1,100.
If you trade Spot Trading, when the price increases to $1,100 you make a profit of $1,000. But you want to maximize profits, so open a Long order with a leverage of 10x.
=> That means you created a buy order for ETH at price $1,000 with volume $100,000. You have essentially borrowed an additional $90,000 from the exchange. At this time, the amount of ETH you have is 100 ETH. If ETH rises to $1,100 and you close your take profit order, you will make a profit of $10,000 compared to $1,000 if you trade normally after returning the loan to the exchange (without deducting interest).
In the opposite case, the ETH price drops to $900 and hits the liquidation price. At this point, the exchange will sell all your 100 ETH at $900 and you must return the entire $90,000 borrowed to the exchange. Your account now has no money left, so your account has been burned.
4.2. Advantages and disadvantages of Margin
Advantage
Optimize capital: Traders with low capital can use leverage to increase profits. If the position is closed successfully, the trader will have the opportunity to earn a much higher profit than usual. For example:Â A trader with a capital of $1,000 can open a position of $100,000 with 50x leverage. If the market moves positively by just 3%, that account will gain $1500. If a $1,000 trading account does not use leverage, the profit is $15.
Make profits even when the market is downtrend:Â A good thing about the crypto market is that you can still make profits in a bearish market by using a short position in Margin. For example, when the price of BTC is 69k, you determine that this is the peak of BTC in this cycle and you open a short position at the price of 69k, with the current price of BTC being 26k, you have succeeded in making a profit in downtrend.
Defect:
Risk from price fluctuations:Â The crypto market has a large fluctuation range and is very sensitive to news, so your position can easily be liquidated in highly volatile markets.
Risk from investors themselves:Â If an investor misidentifies the market trend and uses large leverage, your account can easily be liquidated.
4.3. Notes when using leverage in the Crypto market
Using Margin can open up opportunities to make quick profits. When applied intelligently, you can even earn up to 100 times profits compared to traditional trading, regardless of whether the market is in an up or down trend. However, big profits also come with high risks. Therefore, you should only use Margin when you meet the following requirements:
Experience: You need to be an experienced trader, master the principles of technical analysis, be able to read charts and clearly understand the mechanisms and trends of market impacts. For new traders, especially those who do not understand how Margin works and the cryptocurrency market, using Margin can be dangerous and should not be greedy for big profits.
Stable market: Margin should usually be used when the market shows clear and stable signs of increase or decrease. Avoid using Margin when the market is moving sideways or there are unclear signals.
Short-term trading: Margin is often effective in short-term trading. Using Margin in long-term trading may not yield good performance and may pose a high risk of loss.
5. Conclusion
High profits always come with high risks. Remember, using financial leverage requires a deep understanding of the market and good trading skills. If you are not confident or do not have enough experience, you should avoid using leverage to avoid unnecessary risks.
