What Is Leverage? Pros, Cons, and Examples For New Traders

If you spend any time around trading communities, you will hear the word leverage very quickly.

Used well, leverage can magnify returns on a small amount of capital. Used badly, it can wipe out an account in a single volatile move.

This guide explains what leverage is, how it works in trading, the benefits and risks, and how beginners should think about it.

What Is Leverage?

In finance, leverage means using borrowed money to control a larger position than your cash alone would allow.

Instead of paying the full value of an asset, you put down a smaller amount, known as margin, and borrow the rest from your broker.

If the trade moves in your favor, your returns on that smaller upfront capital are amplified.

If it moves against you, your losses are amplified too.

How Leverage Works In Trading

A simple leverage example

Imagine you have 1,000 dollars.

• Without leverage, you buy 1,000 dollars of a stock
• If the stock rises 10 percent, your profit is 100 dollars, a 10 percent return

Now imagine you use 5:1 leverage.

• You control 5,000 dollars of the same stock
• You still only put in 1,000 dollars as margin
• If the stock rises 10 percent, the position gains 500 dollars
• On your 1,000 dollars of capital, that is a 50 percent return

It looks great when it works.

But if the stock falls 10 percent instead, your 5,000 dollar position loses 500 dollars.

Now you are down 50 percent on your account from a fairly normal price move.

Margin and collateral

To offer leverage, brokers require margin.

Margin is the portion of the trade you fund yourself, which acts as collateral for the borrowed part.

• Initial margin is what you need to open the position
• Maintenance margin is the minimum equity you must keep to avoid a margin call

If your losses push your equity below the maintenance margin, the broker can ask you to deposit more money or close your positions automatically.

Where You Commonly See Leverage

Leverage shows up in several markets and products:

• Margin stock accounts where you borrow against your portfolio
• CFDs and spread betting in some regions
• Futures and options where the contract controls a large notional value
• Forex trading where leverage ratios can be very high

The exact limits depend on regulation and the broker, but the core idea is the same.

You are controlling exposure that is larger than your cash balance.

Why Traders Use Leverage?

Used carefully, leverage can have some advantages.

1. Amplifying returns on limited capital

If you have a small account, leverage allows you to take positions that would otherwise be out of reach.

This can make active trading feel more meaningful in dollar terms.

2. Capital efficiency

Some traders use modest leverage so they can spread capital across different positions.

For example, rather than tying all cash in one stock, they use a bit of margin and diversify.

3. Hedging strategies

Advanced traders sometimes use leverage within hedged positions, for example long and short different instruments at the same time.

The goal there is to target small price differences while keeping net exposure controlled.

Risks Of Leverage You Cannot Ignore

For beginners, the risks often outweigh the benefits.

1. Amplified losses

The same multiplier that boosts your gains will magnify your losses.
A 5 percent market move can translate into a 25 percent hit to your capital if you use 5:1 leverage.

In extreme cases, a single bad trade can wipe out an entire account.

2. Margin calls and forced selling

If your equity falls below the maintenance margin, your broker can:

• Issue a margin call asking for more funds
• Or close your positions automatically to limit further losses

This forced selling often happens at the worst possible time, when prices are already stressed.

3. Higher emotional pressure

Watching leveraged positions swing rapidly in value can be intense.
Fear and greed tend to spike, which increases the chance of impulsive decisions and revenge trading.

4. Overnight and gap risks

Even if you use stop losses, markets can gap on news.
With leverage, those gaps can jump over your stop and create larger than expected losses.

How To Use Leverage Safely

If you do choose to use leverage, approach it as a risk tool, not a shortcut.

1. Keep leverage low

Using 2:1 or less is very different from swinging at 10:1 or 20:1.
Small amounts of leverage are easier to recover from when trades go wrong.

2. Limit position sizes

Do not put a large portion of your account into one leveraged trade.
Many traders cap each position at a small percentage of their capital.

3. Always use a stop loss

Decide your maximum loss on the trade before entering.
Place a stop loss and respect it, even if you feel tempted to move it further away.

4. Avoid highly illiquid names

Leverage plus illiquid stocks is a dangerous mix.
Wide bid ask spreads and low volume can make exits painful and slippage large.

Conclusion

Leverage is simply borrowed money that lets you control a bigger position with a smaller amount of capital.
It multiplies your potential gains, but it also multiplies your potential losses and adds the risk of margin calls, forced selling and emotional stress.

For most new investors, it is wiser to first learn how markets work using cash positions, then decide later if carefully managed leverage fits your style and risk tolerance.

If your goal is to start building a long term portfolio in US stocks and ETFs, you can do that without leverage through an app like Gotrade.

With fractional investing from as little as 1 dollar, you can focus on consistent contributions, diversification and compounding instead of magnifying short term swings.

FAQ

1. What is leverage in simple terms?
   Leverage means borrowing money from your broker so you can trade a larger position than your cash would allow.
2. Is leverage good for beginners?
   Usually not. It makes mistakes much more expensive. Most beginners are better off starting without leverage.
3. Can you lose more than you invest with leverage?
   Yes. With high leverage and fast moves, it is possible to lose more than your initial capital, especially in derivatives or margin accounts.

Reference:

• CMC Markets, Leverage in Trading: How Does it Work?, 2026.

Disclaimer:
Gotrade is the trading name of Gotrade Securities Inc., which is registered with and supervised by the Labuan Financial Services Authority (LFSA). This content is for educational purposes only and does not constitute financial advice. Always do your own research (DYOR) before investing.