Leverage is one of the most fascinating – and sometimes dangerous – concepts in trading, whether applied to stocks, forex, or cryptocurrencies. It allows an investor to control a position much larger than their actual capital, using funds borrowed from a broker.
For example, with just 100€, a trader can open a position equivalent to 1,000€ using 10x leverage. This mechanism multiplies potential gains, but also losses, making it a tool to be handled with caution.
In this article, we will explore in detail the definition of leverage, how it works in practice, its advantages and dangers, and practical examples to better understand its impact.
Key takeaways
- Leverage allows you to trade with greater exposure than your actual capital.
- It multiplies both potential gains and losses.
- Too much leverage can lead to rapid liquidation of the position.
- Used properly, it can be a strategic tool for optimising capital.
Definition and origin of leverage in trading
Leverage is a financial mechanism that allows a trader to increase their investment capacity by borrowing funds from their broker. Leverage is often expressed as a ratio or multiplier: x2, x5, x10, x50, or even x100, depending on the platform.
The concept originates from traditional finance, particularly futures markets and margin trading. With the rise of cryptocurrencies, it has become even more popular, as exchanges like Binance, Bybit, and Kraken sometimes offer very high leverage to individuals.
👉 Simple example:
- Available capital: 500€
- Leverage: x10
- Actual exposure: 5,000€
This means that the trader can speculate as if they had 5,000€, even though they have only invested 500€. This system is based on the initial margin (the trader’s own capital) and the maintenance margin (the minimum amount required to keep the position open). If losses exceed a certain threshold, the position is automatically closed: this is liquidation.
How does leverage work in practice?
To understand how leverage works, we need to distinguish three key concepts:
- Initial margin: This is the trader’s security deposit (e.g., 100€ to open a position).
- Total exposure: This is the actual position size, calculated by multiplying the margin by the leverage.
- Liquidation: This is the point at which losses absorb all invested capital, forcing the automatic closing of the position.
👉 Practical example (crypto trading on Bitcoin with 10x leverage):
- Available capital: 200€
- Leverage: x10
- Open position: 2,000€ on BTC
➡️If Bitcoin increases by 5%, the trader gains 100€ (i.e., +50% of their capital).
➡️If Bitcoin drops by 5%, the trader loses 100€ (or -50% of their capital).
With an adverse movement of -10%, the entire stake is liquidated. This is why leverage is a double-edged sword: it can multiply profits or wipe out capital in a matter of minutes.
📌Good to know: Some platforms offer leverage of up to 125x on Bitcoin. However, a simple movement of -0.8% against the position can be enough to completely liquidate the account.
Why use leverage in trading?
Despite the risks, leverage offers several benefits sought by traders:
- Optimise your capital
- A trader with little capital can access larger positions, allowing them to profit from market fluctuations without requiring huge capital.
- Maximise gains
- With leverage, a relatively small price movement can generate a significant return. This attracts many traders, particularly those in scalping and day trading.
- Diversify strategies
- A trader can spread their capital across several leveraged positions rather than investing it all at once.
- Hedging
- Some investors use leverage to protect themselves from a decline by opening short positions against their portfolio.
👉Example: A long-term Bitcoin investor can open a leveraged short position to offset a potential temporary decline.
However, these advantages must always be balanced with risk management. Improper use of leverage can lead to liquidation in seconds, especially in a market as volatile as cryptocurrency.
