Those who have tried day trading in any type of market might wonder if they would do better if they use leverage or if it’s just a myth that margin-traded accounts increase profits straight away.
It can be difficult to make enough revenue as a trader without a decent account size and for day traders especially, leverage adds that extra buying power that is needed to see larger gains.
This is going to be a complete guide on what day trading is, how it works, if necessary, and what you need to think about if you decide to leverage up your account.
Key takeaways
- Day trading leverage is borrowed capital that requires an initial deposit called margin collateral and is used to multiply position size for day traders.
- Day traders can access a multiplier by choosing a trading platform such as a Forex broker, CFD broker, or a Spread Betting platform.
- When day trading with margin, your potential profits and losses are amplified according to the chosen ratio.
Day trading in general works differently depending on where you live. In the United States, for example, there is a rule called the $25,000 rule which prohibits individuals from executing a certain amount of trades per day if their account size is smaller than $25,000.
In other parts of the world, day trading is a free activity and can also be done with a multiplier.
In this guide, I will explain both versions and how day traders from different parts of the world can use leverage to day trade different asset classes.
You will learn
Day trading leverage explain in simple terms
Leverage in day trading is the use of borrowed money to increase buying power by 10 times, 20 times, and even up to 100 times depending on what ratio you choose.
When credit is used, margin must be added as collateral to be able to enter the market with a position (very similar to how banks ask for collateral when you borrow money).
You must learn to separate these two components.
- Margin = Your own capital
- Leverage = The borrowed capital
Related: Differences between leverage and margin
The primary use of credit for day traders is when short-term trades are taken where the traders scalp a few points up or down in price. Keep in mind that leverage can be used for short-selling as well which allows you to make money in both ways.
Through the use of margin-traded accounts, day traders can make significantly larger profits from very small movements and this is why so many turn to these types of accounts.
When borrowed funds are used in a profitable trade, your profits are amplified by how much credit you have used for that specific position. For example, if you use a ratio of 1:100, your profits are increased 100 times.
Your losses are also amplified with the same magnitude and this is where most traders realize the drawdown of using margin accounts.
The leverage itself comes from a broker that lends out capital at a very low cost to its traders and in return they earn money from increased fees.
The most common types of brokers that offer margin are CFD brokers, Forex brokers, crypto exchanges, spread betting brokers, and other margin-traded trading platforms.
Related: Why do brokers offer leverage?
When a multiplier is used for day trading, the fees are also increased.
Read our guide on leveraged commissions to learn the specifics of fees.
Is it a good idea to borrow capital when day trading
Yes, you can, nowadays it is very common to day trade any financial asset among both retail and professional traders.
Novice traders tend to use higher levels of margin and expose themselves to more risk while more experienced investors use it more carefully and systematically.
Most day traders seek to open accounts with a CFD broker, a forex broker, a spread betting platform, or the highest leverage crypto exchange when they are looking to increase output.
Most traders also don’t know it but forex brokers have built-in margin by default.
Here traders control their risk through position sizing.
The only thing needed to get started is to sign up with a broker, send in your KYC documents, and you are ready to start trading.
Since accessing borrowed funds is a simple tool in today’s trading almost any day trader who wants to boost their profitability can open an account with a margin broker.
This is how it all works
Borrowing money in day trading works the same way as in any other type of speculative product.
First, you have a broker that provides multipliers to its traders after the first deposit as an initial investment.
This deposit is then used as collateral to open larger positions.
Secondly, the size of the position is controlled when the trader chooses the ratio.
Lastly, day traders can only use the borrowed capital when the position is active and have to pay it back once the trade is closed out.
Since day traders typically open several trades per day, they have to borrow capital each time they enter a position.
This can increase the costs of doing business since the fees are also amplified due to larger position sizes.
When the trader scores a profit he or she will realize a larger gain than normal and when a loss is realized it is also amplified depending on the position size.
You need to learn about margin requirements as well
Every trade that is opened with leverage has two components, margin, and the borrowed funds.
The margin requirement is the trader’s cash that is first deposited into his or her trading account.
Every broker will ask for a minimum deposit as margin requirement.
It is the margin capital that is used to calculate how large the trade size will be combined with the selected ratio.
Suppose you want to know your margin requirement for a position size worth $12,000 at a ratio of 1:60.
Simply divide $12,000 by 60 and you will get $200 which is your margin requirement to open this trade.
The trader’s cash is typically only a small part of the total value of the trade since most traders use higher ratios.
Step-by-step guide how you can do it yourself
The process of getting started with leveraged day trading looks very similar for almost any asset class.
Here is a short step-by-step guide on how to begin:
- Find a reputable broker.
- Create an account.
- Send in your KYC documents.
- Make your initial investment.
- Screen the market for a good opportunity and apply your top strategy.
- Select the position size and trade direction (long or short).
- Add your protective stop and enter the market.
- Monitor and manage your trade.
Related: Strategies for leveraged markets
Day traders also use leverage to hedge positions.
This is a common strategy to protect the position against unwanted losses.
2 examples to give you the full picture
Below are two examples of how day trading can be done with increased buying power.
In the first example, we will take a look at a standard long position in Apple, and in the second example, I will go through how short-selling works.
Example 1
Let’s say you want to enter a long trade in Apple worth $24,000.
Your initial deposit is $800, now you need to figure out how much extra capital you need to use.
We divide $24,000 by $800 and the answer is 30 which means a ratio of 1:30 must be used.
Related: Leverage trade calculator
Suppose you enter in the morning by 10.00 and within 15 minutes you’ve made a profit of +0.75%.
Once you close this position you’ve made a total profit of $180.
Here is the calculation: $24,000 x 0,0075 = $180
This is the result of using borrowed money to increase your profits in a very effective way.
Keep in mind that at this ratio your liquidation price will shrink and get closer to your entry price.
Example 2
Assume you want to short Bitcoin with $40,000.
You begin by depositing $1200 into your crypto exchange account.
First, you need to find out how much credit you are going to need.
We divide $40,000 by $1200 and find out that the correct ratio is 33x (or 1:33).
Imagine that you enter your short position around 15.00 and before 16.00 the crypto market has dropped -5,50%.
You buy back your Bitcoin short position and realize a profit of $2200.
Here is the calculation: $40,000 x 0,055 = $2200.
This means that in less than one hour you were able to nearly double your account size with leverage.
In this case, it would also be practical to use our short profit calculator to find out exactly how much you stand to gain when shorting.
How you can calculate your buying power in an easy way
The calculation for day trading buying power works by combining your margin plus the chosen ratio. For a $50 account, for example, make sure you choose the best lot size for $50 to maximize your leverage without overexposing your capital.
Let’s assume your current cash balance is $300 and you want to use a ratio of 1:55.
To calculate your buying power simply multiply your cash balance and your ratio.
In this case, the total buying power would be $300 x 55 = $16,500.
This calculation works for any asset class as long as you know your total account value and your ratio.
Conclusion
This guide is a breakdown of how leverage works in day trading and how day traders use this tool to score bigger profits.
The question of whether it is a good solution for you or if it will do more harm always comes down to personal preference and risk tolerance.
If you are a risk-averse trader you can use low levels of credit to stay safe while trading.
However, if you are comfortable with risk and you are an experienced day trader, you can boost your profitability significantly with the use of margin.
After reading this guide you will have a good understanding of the concepts involved in day trading with leverage.
