Quick definition Leverage is controlling more assets than you have capital for. You put up 1 dollar, borrow 1 dollar, and control 2 dollars of assets. This is 2x leverage. What it is All traders use some leverage. Even a stock trader who uses margin uses leverage. Leverage multiples include: - 2x leverage: common for stocks - 5x-10x: common for futures and options - 20x-100x: available for crypto and forex Higher leverage magnifies both gains and losses. Why it matters Leverage magnifies returns. With 2x leverage, a 10 percent gain becomes a 20 percent return. But leverage also magnifies losses: a 50 percent loss wipes out your capital entirely. Leverage is essential for many strategies (derivatives trading, short selling) but dangerous if mismanaged. Leverage ratios Leverage ratio = assets controlled / capital. 2x leverage ratio means you control twice your capital. 10x means you control 10 times your capital. High leverage is common in professional trading but rare in retail accounts. Deleveraging When markets stress, leveraged traders are forced to sell positions to reduce leverage. This creates selling pressure and amplifies declines. A deleveraging cascade can occur where forced selling leads to more forced selling. Practical example You have 10,000 dollars. You take 2x margin (10,000 dollar loan) and invest 20,000 dollars in a stock. The stock rises 50 percent. Your position is now worth 30,000 dollars. You repay the 10,000 dollar loan and keep 20,000 dollars profit (200 percent return on 10,000 dollars capital). If the stock falls 50 percent, your position is worth 10,000 dollars. You repay the loan and have 0 dollars left (total loss of capital). Even though the stock only fell 50 percent, you lost 100 percent of your capital. Danger High leverage is dangerous. A small adverse move can wipe out capital. Most leverage-related disasters involve excessive leverage. Brokers manage leverage through margin calls and forced liquidations. See also - Margin - Margin Call - Leverage Ratio - Deleveraging
