Spot Trading vs Leverage Trading: What Is The Difference?
Let’s break down the difference between spot trading vs leverage trading. This is a common question that many traders struggle to solve on their own simply because they don’t know the difference.
First, let’s pinpoint exactly what each of these trading styles means, and then we’ll compare them to see exactly how they are separated. After reading this article, you’ll have a basic understanding of both concepts and you’ll be able to choose which one suits you best.
I want to start by saying that leverage trading is increasing in popularity every year and it only makes sense to learn the difference between how the spot market and the leveraged market work.
Many traders discover that spot trading is not for them while others feel that leverage trading is too risky and they stay in the spot market. This is a personal opinion for each individual and it all comes down to your risk appetite, style of investing, and perhaps your bankroll.
Usually, traders and investors will smaller accounts tend to lean towards leverage trading as they benefit from increased buying power.
To learn how to choose the optimum leverage ratio, read our guide on the best leverage ratio for beginners and what is 100x leverage?
The difference between Spot Trading and Leverage Trading
The true difference between the spot market and the leveraged market is the borrowed funds you receive from your broker while leverage trading. In spot markets, you do not receive any extra funding from your broker and you can only trade with the money you have deposited into your account. While in the leveraged market you gain access to extra buying power through funds that the broker lends you in an automatic way which is the big difference.
When trading the spot market you are essentially buying or investing in the true underlying asset, for example, a stock or a cryptocurrency. The opposite happens when you invest in leveraged markets where you are only buying a contract that mirrors the price of the real asset.
- Spot markets are traded with your own funds only where you own the underlying asset.
- Leveraged markets are traded with borrowed funds lent to you by your broker.
- Leveraged markets are contracts that mirror the price of the real asset.
Of course, when investing through a broker that offers leverage you can choose to leave the leverage ratio at 1:1 and only invest your own money. Keep in mind though that some leveraged brokers will automatically add leverage to your position size and the only way you control your risk is through the position size.
Why brokers offer leverage to beginner investors is first of all to make more money through increased fees and higher risk.
What is Spot Trading?
Trading the spot market means that you are trading the real market where you can buy an underlying asset and have ownership of that asset. For example, if you trade the spot stock market you essentially buy the real stock from the stockbroker and now you own a piece of the company.
The same thing goes for crypto spot trading, when you buy a cryptocurrency in the spot market it is yours to keep and you can add it to your personal wallet and send it out from the exchange at any time. The spot market gives you access to the underlying assets
Spot trading happens on stock exchanges that have access to the real market and the actual stocks that have been issued by companies. When you buy a stock in the spot market you invest in the real underlying asset and not a contract of some sort.
Another important aspect of the spot markets is that you are only allowed to trade with your own capital and there are no borrowed funds involved in this style of investing. What you deposit into your investing account is what you have access to and that’s it.
When you search for Apple stock or Tesla stock on Google and you get the price chart you are looking at the spot market of the Apple and Tesla stock which represents the true price of both companies. T
o be able to buy these stocks you need to sign up for a spot market stock exchange and invest your own money. Spot trading is also considered to be a low-risk investment compared to leveraged products.
Pros and cons of spot market
|Direct ownership of the underlying asset||Difficult to profit for traders with small accounts|
|A good way to start out for beginners|
What is Leverage Trading?
Leverage trading is a way of investing in the financial markets with borrowed money for added purchasing power and is always attributed to contract trading. Derivatives are the most common contracts for leveraged products and they include futures, options, swaps, and perpetual contacts that offer leverage. This style of investing with leverage is seen as riskier for beginners but a very good way to increase profits if you know how to handle the market swings.
When you trade these contracts you do not get ownership of the underlying asset but instead, you trade the mirrored price of the asset in question. For example, if you were to leverage trade stocks, such as Apple stock, for example, you are not directly purchasing the Apple stock, you are buying a contract that reflects the real price of the stock. Many leveraged products are more flexible and some investors prefer them over the real asset on a stock exchange.
To get access to these products you need to find either a leverage CFD broker or any other broker that offers derivatives contracts. Futures exchanges and options trading platforms are other ways for you to access these products and increase your buying power.
Not all brokers and platforms will show you the leverage they add to the contracts which makes it difficult for you to know your margin ratio and the risk tolerance of the position. I recommend that you only trade with brokers and platforms that clearly let you choose the leverage ratio so you can control your risk.
Leverage in forex trading is a very common aspect that beginners use to both increase winnings and enable smaller accounts. It’s worth mentioning that leverage can both increase profit and loss and you could end up losing more than 100% with leverage if you are not careful.
Pros and cons of leverage market
|Investors get access to more capital||Unexpected losses can occur for beginners|
|Gives the flexibility to trade several markets||Increased fees with leverage|
|Benefits experienced traders||Difficult to understand for beginners|
Questions asked by other traders
The short answer is that spot markets offer no extra capital and let you trade the underlying asset in a less risky environment. Leverage gives you access to borrowed funds to increase your buying power through derivatives contracts that are mirrored contracts of the underlying asset.
No, you either trade the spot market without leverage or you trade a leveraged contract. But, you can trade a leveraged market with a 1:1 ratio of leverage which in essence is the same thing as trading without leverage.
The spot market is better for beginners for a couple of reasons. The risk is much lower and the fees are not amplified. Leverage is better for experienced investors that benefit from added purchasing power in good opportunities.
No, this is not possible. In order to short-sell a market, you need access to a leveraged trading platform that offers derivatives that offer short-selling. It is not possible to directly short-sell on a spot market trading platform. To learn more about this topic, read our guide: Short selling and leverage explained.