What is leverage in trading and how does it work?

Leverage in trading allows market participants to control a large position size with a relatively small amount of capital. It functions as a loan provided by a broker to increase potential buying power. For example, with 10:1 leverage, a trader can control a $10,000 position using only $1,000 of their own collateral, known as the margin. When using leverage, your profit or loss is calculated based on the total value of the position rather than the initial margin deposit. If a trader holds a $10,000 position and the asset price moves up by 5%, the gain is $500. This represents a 50% return on the $1,000 margin used. Conversely, if the price drops by 5%, the loss is $500, which is 50% of the initial capital. Brokers maintain strict margin requirements to cover potential losses. If a trade moves against you and reduces your account equity below the required maintenance margin, the broker will issue a margin call. This requires adding more funds or closing the position immediately. Trading with leverage involves significant risk because it magnifies both gains and losses. It is possible to lose more than your initial investment in certain market conditions.