What is Leverage?
Have you ever wondered how investors get the best out of the stock market? Financial experts have come up with different trading strategies to help investors to optimize their efforts. One of which is leverage.
Leverage is an investment strategy that involves using borrowed money, especially borrowed capital, to increase the potential return on investment. The potential for loss is also greater. A common reason for using borrowed capital to fund an investment is to raise an investor’s buying power, resulting in higher gains or losses. Leverage for individuals usually comes in financial instruments such as futures, options, and margin accounts. Companies use leverage to finance assets. For more context, companies use debt financing to invest in business operations to increase shareholder value.
Types of Leverage
Leverage comes in different ways. There are two main types of leverage:
Financial Leverage: This is a well-known type of leverage. It involves borrowing leverage in your portfolio through margins for individuals and corporate debt for the company.
Operating Leverage: This generally involves the fixed operating cost of running a firm. These expenses combined with higher revenue or profit magnifies the potential of greater losses or profits of a company.
There are other types of leverages cited in different perspectives.
What is a Margin?
Margin is a type of leverage that involves using existing cash or securities as collateral to increase your buying power. You can borrow money from a broker for a fixed interest rate to purchase securities. It is often termed as an out-of-pocket investment due to the risks involved.
Benefits of Margin
Higher returns potential: With the prospect of having more returns, leverage may build an investors’ confidence. Margin trading can boost your gains or losses, allowing you to strategize your portfolio in a more effective manner.
Diversification: An increased buying power allows you to diversify a concentrated portfolio.
Risks of Margin trading
Potential higher losses: The chances of losing more money is also high. A decline in the value of securities that are purchased on margin may require you to provide additional funds to the firm that has made the loan to avoid the forced sale of those securities or other securities in your account.
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Margin trading entails greater risk, including, but not limited to, risk of loss and incurrence of margin interest debt, and is not suitable for all investors. Please assess your financial circumstances and risk tolerance before trading on margin.
Diversification strategies do not ensure a profit and do not protect against losses in declining markets
*Other charges may apply, including Passfolio Pro subscription fee