Can You Lose More Than You Invest With Leverage?
Can you lose more money than you invest with leverage or is this just a myth among traders? The truth will probably scare you at first but when you realize how a margin account works you will be on track to execute proper risk management in leverage markets.
In addition to this guide, I recommend reading this article to get the full picture:
Now it doesn’t matter how much money you have or even if you select the best leverage ratio for beginners, the fact that losses can hurt you badly is always going to be present when using borrowed money to increase purchasing power.
In this guide, I will explain how much money you can lose with leverage, some differences between leveraged and non-leveraged accounts and if it’s true that you can lose more than you have initially invested.
I will also give you a couple of great tips at the end of the guide that you can implement today to make sure that you never owe more money than you have invested to a broker.
- You can lose more money than you have invested in forex, stocks, and crypto if you use a broker that does not offer negative balance protection.
- Before losing more money than you have in your margin account you will receive a warning signal called a margin call telling you that you are running out of funds to support your open losses.
- To protect yourself from owing money to your broker make sure to use a broker, leverage trading platform, or crypto exchange that offers negative balance protection.
This is how much you can lose with leverage (Forex, Crypto, Stocks)
When you open an account to trade with leverage it is possible to lose more than you have invested and this goes for all asset classes and all markets including forex, stocks, and crypto trading.
The correct question we should be asking ourselves is whether it is possible to lose more than you have invested when trading on a CFD broker, Forex broker, or a cryptocurrency exchange.
It has nothing to do with the specific market, instead, it depends on what type of broker you are using.
Now, you can only go into a negative balance in your trading account if the platform you are using does not offer proper risk management tools to stop losses from becoming larger than the total value of your account.
Most popular CFD brokers for stocks, crypto leverage trading exchanges, or forex brokers have a security feature for all their margin accounts called negative balance protection which will stop all losses from ever getting larger than the total value of your deposited money, or your collateral money.
Should your broker not offer leveraged crypto trading or stock investing with negative balance protection it is possible to lose an infinite amount of money until the brokerage itself closes out the position to save you.
Without negative balance protection, it is possible to lose more than you invest in forex and other markets due to overleveraging your account and not closing out the losses before they get too big.
This is how a leveraged trading account works
Can you lose more than you invest with a leveraged trading account and how does the negative balance protection work?
As a trader, you need to learn how a leveraged trading account works before you get started. Without this basic knowledge, you will make unnecessary mistakes that might cost you a lot of money.
There are two types of trading accounts:
- With negative balance protection (safe)
- Without negative balance protection (risky)
There are also two components to an account that has leverage:
- Margin collateral = Your own money
- Leverage = The borrowed money
Each position is built up of your margin collateral (your deposit money) and the leverage (the borrowed money) that you receive from your broker.
Your losses and profits are calculated on the total position value with both your money and the leverage combined.
Example 1 of leverage trading account with negative balance protection.
For example, if you deposit $500 and you use a 1:75 leverage ratio your maximum buying power is $37,500. Now, if you take a -1.5% loss, that would mean a total loss of -1.5% on $37,500 which is -$562,50.
In this case, your total margin balance was $500 and would not be able to withstand a loss of -$562,50. What happens here, assuming that your broker has negative balance protection, is that your broker liquidates your account to prevent further losses from happening.
That was an example of an account with negative balance protection
Example 2 of a leveraged trading account without negative balance protection
This would give you a buying power of $100.000.
Now, if your trade goes against you with -2% you have an open loss of -$2000.
That’s more than the total account value or the initial deposit that you made.
In this case, the broker will let your open loss fall freely until you close it out yourself.
This can cause huge losses and in some cases, you can even go into debt with your forex or stock broker if you are not able to directly pay back the loss.
The recommendation is to always trade with a broker that offers negative balance protection.
Most high leverage trading brokers today offer leveraged accounts with this security feature.
Warning signs that you are about to lose all your money
What happens if you use leverage and lose?
Every margin account has a feature called margin call which is a warning signal that you are close to losing your margin collateral.
- A margin call signal to the trader that he is almost out of funds to support the overall losses in the margin account
This means that your open losses have almost surpassed your total account balance and you either need to close out the position by taking the loss or deposit more funds to withstand the losses.
How to deal with a margin call?
There are three things you can do when receiving a margin call. First, you can close out the position and take the loss. This is usually the recommended choice unless you are a very experienced trader.
Second, you can deposit more money to meet the margin call and lift your margin levels. This involves a great amount of risk as your position has clearly been miscalculated and is going against you.
Thirdly, you can wait and do nothing and hope for the best. Obviously, this option is the riskiest as you are essentially leaving your account to chance.
5 ways that can protect the money in your margin account
Can you lose more than you invest with leverage in any type of account?
As mentioned earlier, the best way to protect your leveraged account against unwanted losses is to use a broker that supplies negative balance protection.
However, the negative balance protection feature is only good in a worst-case scenario where you run the risk of losing all your margin collateral.
Here are 5 other tips that can help you when trading with leverage:
- Use a stop loss – A stop loss is a tool that limits the loss of a trade to a certain dollar value or a percentage. When opening a position in the FX markets you can add a stop loss that will automatically close your position if the position goes against you and causes a -$50 loss.
- Use isolated margin – Isolated margin will isolate the margin requirement for each position you open. This will prevent one position from losing all your collateral money in your account and will instead only lose the amount that was required to open that position alone.
- Calculated your leverage – Calculating your leverage is a very good way to not overleverage and to keep your losses smaller. This will not prevent you from losing but it will give you an idea of how much leverage to use. Calculating your leverage can be done with a leverage calculator for forex.
- Use the right strategies – The leverage trading strategy that you choose is going to determine how successful your operations are going to be. This goes for both profits and losses. A top leverage trading strategy will prevent large losses from happening while still being able to profit from good opportunities.
- Choose the right leverage ratio – Choosing the best leverage ratio in forex is a key part of finding the optimal mix of leverage for your account. If you choose a low leverage ratio you are not going to see the profits you want and if you overleverage you are going to take on losses that you can’t handle. There is a sweet spot for each trader.
A bonus tip is to use a liquidation price calculator to find out exactly at what price your leveraged position will get liquidated. Or you can use a margin call calculator to prevent your position from reaching that critical level.
Frequently asked questions
Yes, it is possible to get a negative account balance when trading with leverage. However, this can only happen if your forex broker or stock trading platform doesn’t offer negative balance protection.
There are three big dangers of leverage trading. First, your losses are multiplied in correlation to your chosen leverage ratio. Second, overtrading is a common trait among many traders that try leverage for the first time. Lastly, leveraged fees and commissions can easily eat up your account if you are not careful.
For a beginner, choosing a leverage ratio between 1:2 and 1:10 is going to be a safe level. Going higher than this will reduce the distance to your liquidation price and might cause you to get liquidated.