Leverage is an important concept in the stock market, that every trader should be aware of. It is a powerful tool that can help multiply your investment potential and returns. But what is leverage and why do traders choose to use it? Here’s everything you need to know about the concept of leverage and its various advantages.
What is Leverage trading?
Leverage trading involves entering into large positions, long or short, by depositing only a small percentage of the total trade value as margin. To put it simply, leverage, coupled with zero brokerage, enables you to take up large trades even if you don’t possess the necessary capital required for the position. Traders who look to use small price movements on an asset to generate profits often use leverage trading since it allows them to take up large positions, potentially multiplying their returns.
How does Leverage trading work?
Leverage is often expressed as a multiple such as 5x or 10x. Some stockbrokers express it using ratios such as 5:1 or 10:1. The higher the ratio or multiple, the higher is the leverage. For instance, if your stockbroker offers you a 10x or a 10:1 leverage, what this essentially means is that for every 1 Rupee you deposit, your purchasing power increases by 10 times. So, if you wish to purchase a share of a company that’s trading at ₹100, all you need to do is deposit ₹10 instead of the entire trade value. This is how leverage in the stock market enables you to take up large positions by depositing only a fraction of the value as a margin.
The pros of Leverage trading
The advantages of leverage trading are plenty. Let’s take a quick look at a few of the most important ones.
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Allows you to enter into large positions
This is by far the most obvious advantage of leverage trading. By simply depositing a small percentage of the trade value of say 10% or 20%, you can enter into much larger positions. Using leverage, you can gain access to high-priced stocks which would otherwise be out of your purchasing power. -
Enables you to get higher returns
Since leverage trading allows you to purchase more shares, you get the chance to get higher returns on your investment. For instance, with a 5x leverage, you can purchase 5 times more shares. And if the market moves in your favour, you stand to gain 5 times more return on your investment. -
Allows efficient use of capital
Leverage allows you to use your capital in a more productive manner. For example, you can free up some funds by maintaining a small balance in your account without impacting your ability to trade. The freed-up funds can then be invested elsewhere in other low-risk investment options to diversify your portfolio. Alternatively, you can also take up multiple positions, long and short, in different stocks simultaneously to increase your profit potential and decrease risk. -
Enables you to trade even during periods of low volatility
With leverage, you don’t require high price fluctuations to generate profits. By entering into large positions, you can still generate meaningful returns even during bouts of low volatility.
Example of Leverage in stock trading
Here’s an example that can help you better understand the concept of leverage in the stock market.
Assume that you wish to enter into a long (buy) position in Reliance Industries Limited. You purchase 1,000 shares of the company at a current market price of ₹2,400. Now normally, to purchase 1,000 shares of Reliance Industries, you would have to pay ₹24,00,000 (₹2,400 x 1000 shares). However, since you’re planning to trade intraday, your stockbroker offers you the benefit of leverage trading.
Let’s assume that you get 75% funding in Reliance Industries Ltd. So, to take up an intraday position worth ₹24,00,000, you will have to deposit ₹6,00,000 as margin.
Assuming the market moves in your favour and the share price goes up to ₹2,500 in just 20 days, your total profit would be ₹100 per share (₹2,500 - ₹2,400), which translates to around ₹1,00,000 (₹100 x 1,000 shares). Even after accounting for 20-day interest of ₹9,360 (9.49% p.a. on funding of ₹ 18,00,000) you’d still generate a return on invested capital of 15% on a stock movement of 4.16%. All this is possible because of leverage.
So, if you’re planning to indulge in leverage trading, m.Stock is the right place. With our Margin Trading Facility (eMargin), you get up to 80% funding in 700+ stocks at one of the lowest interest rates, starting at 6.99%. This facility comes with zero subscription fees and zero brokerage charges when you open an m.Stock account. So, don’t let market opportunities pass you by, open demat account and invest big with MTF today!
