How Does Leverage Trading Affect Profit?
In this article, we will dive deeper and explore how leverage trading affects profit and how traders can capitalize on the use of borrowed funds.
Leverage trading is the most popular way for traders to trade bigger and potentially increase the profit in financial markets.
By using a leverage broker that offers leveraged products, traders can amplify their bets to maximize profitability.
Those who keep risk under control could possibly be rewarded with windfall profits of up to x10 and even x50.
Key takeaways
- Leverage can increase profit by allowing traders to open a leveraged position that is much larger than their normal size. The more leverage used, the larger the potential profit gets.
- The three most prominent factors that decide how big a profit can get are the leverage ratio, the market conditions, and the strategy used.
- Leverage also increases the risk by the same amount and it is important to have a trading plan to reduce the potential for loss such as using a stop loss and other risk management techniques.
Content table
- How leverage can increase profit
- Explanation how leverage affects profit
- Examples of profitable leverage trades
- Comparison of profit with and without leverage
- Factors affecting profitability
- Does high leverage increase profit more?
- Strategies for maximizing profits in leverage trading
- Frequently asked questions
- Conclusion
How leverage can increase profit
Trading with leverage can amplify potential profits simply by trading positions that are x5, x20, or x100 larger.
If a trader makes a deposit of $100 on a trading platform that offers leverage and uses 1:100 leverage, the total position size is now worth $10,000.
A 2% profit on a position worth $10,000 is equal to $200.
$10,000 x 2% = $200
Compare that to making the same 2% profit on the initial deposit of $100 with 1:1 leverage, which is the same as trading without leverage.
The total profit would be only $2.
$100 x 2% = $2
This is how leverage trading can affect profits in a positive way when the market goes in the right direction.
By controlling only a small fraction of the total position size as margin requirement, leverage can amplify gains massively when used in the right way.
When a leveraged trade is profitable and closed out, the profits will be credited to the trader’s account and the leverage is paid back to the broker.
Explanation of how leverage affects profit
When a trader uses a 1:10 leverage ratio and opens a position at a broker all the profits made will be increased by 10 times.
Let’s say that you use a leverage ratio of 1:10 on a top Bitcoin leverage exchange to trade Bitcoin.
If your initial deposit is $500, the leverage will increase your position size to $5000.
Once you buy Bitcoin for a total value of $5000 and make a profit of 4% the total profit will be worth $200.
It is the increase in the size of the position size that increases the profits which is why leverage is so widely used.
Every time you increase your leverage ratio, your position size increases and all your potential profits increase as well.
Examples of profitable leverage trades
Profitable leverage trades can be very effective in several different markets, including crypto, spread betting, forex, stocks, and commodities.
A trader might use spread betting leverage to try to profit from a small move in the currency market by using a larger position size.
Instead of profiting $2 per point, with 20x leverage you can profit $40 per point.
This makes a big difference when spread betting with a small account while scalping small price movements.
For example, a spread betting setup might provide a 5-point profit and with leverage, you can make significant gains from this minor change in price.
A 5-point move in the market with a $2 profit per point is not much and will result in a profit of only $10.
However, using a leverage ratio of 1:20 will increase the profit 20 times and your 5-point spread bet will now result in a $200 profit.
You can use our spread betting calculator to find out how leverage can increase your profit while spread betting.
Comparison of profit with and without leverage trading
It is easy to explain how profits are made with and without leverage.
Imagine a forex trade where you deposit $500 in your high leverage forex broker that allows you to trade with 200x leverage.
Adding 200x leverage to your $500 initial deposit will result in a total position size worth $100,000 which is a standard lot in forex.
If the market moves in your favor by 50 pips, it would result in a profit of $500.
That is a 100% gain on your total account balance and all thanks to the leverage used.
Now, imagine this trade without leverage.
The total position size would be $500 which is the same as half a micro lot and each pip would be worth $0.05.
A 50-pip market move would then result in a $2,50 profit.
Here you can clearly see the difference when you compare profits with and without leverage.
The relationship between leverage and lot size in Forex is complex where the lot size is the number of units traded for each currency pair and leverage is the multiplier of your deposited capital.
Factors affecting profitability in leverage trading
The two key factors to consider that can significantly increase profitability are market volatility and the chosen leverage ratio.
A slow and dull market does very little for your P&L because at the end of the day if the market doesn’t move, your profit won’t either.
It doesn’t matter if you use a broker that offers 1:1000 leverage if the price doesn’t move.
The same goes for the leverage ratio that you choose.
The more leverage you add the more profitable will your trade be.
A trade that makes a profit of 5% will have totally different results at different leverage ratios.
Let’s assume you trade stocks with leverage and your account balance is $1000.
You take two trades where you use all your margin and both trades make a profit of 5%.
For the first trade you trade without leverage and for the second trade, you add 1:50 leverage.
Your first trade will make 5% of your total account balance which is $50.
The second trade which is leveraged will be 50 times more profitable and earn a profit of $2500.
When you combine both of these factors in your leverage trading strategies your profitability is set to skyrocket.
Does high leverage increase profit more?
For this explanation, we are going to assume that your trade is profitable.
If you take a profitable trade that makes 2% and add leverage to it, you will increase your profitability based on the leverage ratio you choose.
For example, let’s imagine that your current account balance is $8000 and you are trading Tesla stock.
After your entry, Tesla increases 2% over the next 5 hours and you close out your position with a $160 profit.
The next day, you are back to trading Tesla but now on a platform that offers leverage.
You decide to add 1:75 leverage to your position because you are very confident that Tesla will keep rising in price.
You are correct in your prediction and Tesla increases another 2% for the day.
You close out your trade, but how much do you profit with 1:75 leverage?
The correct answer is 75 times more than the day before which would equal $12,000.
Since your position size was 75 bigger, your profit will leverage will therefore be 75 times larger.
$160 x 75 = $12,000
Here you can clearly see how high leverage increases profits to a great extent.
Strategies for maximizing profitability in leverage trading
Leverage is a powerful tool that can help you maximize your profitability when used with the proper strategies.
It’s important to have a solid plan in place that takes care of both entries and exits without any hesitations.
A good plan always takes into account your risk tolerance, your profit goals, the market conditions, and of course the market you are trading.
Also, by using a combination of a well-thought-out plan and technical analysis you can potentially identify better opportunities that can, later on, be amplified with leverage.
Leverage also gives you the possibility to diversify your portfolio even if you are day trading with leverage.
Leverage in long-term investing is not as common as it is often seen as a short-term strategy and therefore riskier.
Adding more cryptocurrencies to your crypto leverage trading strategy will most likely help you out with profitability if your strategy is solid.
FAQ
A 10x leverage ratio means that your profits are increased 10 times. For example, if you profit $100 on a trade without leverage, if you add 10x leverage to the same trade, your profit will be $1000.
No, not necessarily. The truth is that 5x leverage means 5 times profit if you decide to use all your margin capital. This happens because your position size will then be 5 times larger than it was initially. However, you can trade 5x leverage with half of your account size, and therefore the profitability will change
This depends on how big your profit is. It could be 2%, 5%, 10%, or even 50% depending on the setup. To clear things up, I will say that trading $50 with 100x leverage will increase the position size 100 times and result in a position size of $5000.
Conclusion
Trading the financial markets with leverage can increase the profitability of your positions, but remember, this doesn’t come without risks.
Traders must carefully examine the market condition and choose the right leverage ratio before choosing to enter.
Poor judgment and a lack of planning can result in devastating results.
Learning how leverage affects profit in crypto, forex, stocks, spread betting, and any other market will help you maximize your potential for success.
The first step to reaching better profitability is to create a strategy, figure out a plan, and understand your market before you start trading with leverage.
As a final word, it doesn’t matter how profitable your trading plan is, even with leverage, if you can’t control your losses you are going to end up empty-handed.
Therefore, research how you can best avoid risks through careful risk analysis and risk management.
This combined with a good high leverage trading strategy is a good start on your way to better profitability.
