What is leveraged investing? An in-depth understanding of how leverage trading works and its risks

Core Concepts of Leveraged Trading

Leveraged investing is a trading strategy that amplifies investment positions by borrowing funds. In simple terms, investors do not need to pay the full amount upfront; they only need to provide a portion of the capital as margin to control a larger asset. This approach is derived from the physics principle of leverage — using a small force to move a larger object.

In the investment market, the operation of margin trading is as follows: investors provide a margin, and brokers or trading platforms extend credit based on this amount. For example, with 10x leverage, an investor only needs to put in 1,000 yuan as margin to trade assets worth 10,000 yuan. When market trends are favorable, this method can significantly multiply returns; conversely, losses are also magnified.

Margin and leverage are related but distinct concepts. Margin is the funds that investors must pledge to open a position, while leverage is the additional credit extended by the trading platform based on that margin. For instance, if an investor deposits 50,000 yuan as margin and the platform offers 20x leverage, the total assets they can operate amount to 1 million yuan.

Why Does Leveraged Investing Carry Risks?

The biggest hidden danger of leverage trading is the so-called “liquidation” risk. When market fluctuations exceed expectations, causing the investor’s account net worth to rapidly decrease, the platform will forcibly close positions to protect its interests. If the investor cannot replenish sufficient funds within a limited time, the system will automatically sell all holdings, locking in losses.

Taking the Taiwan stock index as an example, if an investor operates with 5x leverage, with an initial capital of 100,000 yuan (controlling a 500,000 yuan position). Suppose the Taiwan index drops by 5%, resulting in a loss of 25,000 yuan, which is a quarter of the initial capital. If the decline continues to 20%, the initial capital faces the risk of being completely exhausted.

Additionally, leveraged trading requires paying overnight fees. While the trading platform provides credit, it charges interest on borrowed amounts, which adds extra costs for long-term holdings. Therefore, leverage investing is most suitable for short-term trading strategies rather than long-term holding.

The Dual Nature of Leveraged Investing

Advantages

Enhancing capital efficiency — Small investors can enter the market with less capital to make large trades, greatly lowering entry barriers and transaction costs. For example, with only 10,000 yuan, a person has limited options without leverage, but with 5x leverage, they can control assets worth 50,000 yuan, seeking more investment opportunities.

Magnifying profit potential — When the market moves in the expected direction, leverage can accelerate gains. If a stock rises by 20%, the profit without leverage is 2,000 yuan; with 5x leverage, the same increase yields a 10,000 yuan profit.

Disadvantages

Risk amplification and increased liquidation probability — The higher the leverage, the more sensitive the account is to market fluctuations. Under the same loss percentage, larger leverage results in greater account loss amounts, increasing the risk of liquidation.

Losses are magnified — When using leverage, any trading loss will be proportionally larger. Therefore, effective risk management and timely stop-loss are crucial for leveraged traders.

Common Leveraged Investment Tools

Futures Trading

Futures are contracts where two parties agree to buy or sell a specific commodity at a predetermined price at a future date. Many import-export companies use futures for risk hedging — locking in future commodity prices to avoid exchange rate fluctuations or raw material cost changes.

The futures market covers a wide range of underlying assets:

• Metals: Gold futures, silver futures, copper futures, etc.
• Indices: Dow Jones Industrial Average, S&P 500, NASDAQ, Hang Seng Index, etc.
• Agricultural Products: Wheat futures, soybean futures, cotton futures, etc.
• Energy: Crude oil futures, natural gas futures, coal futures, etc.

Options (Derivatives)

Options, also known as “call/put options,” give the holder the right, but not the obligation, to buy or sell an asset at a predetermined price at a future date. Compared to futures, which are relatively straightforward (buy low, sell high or vice versa), options involve complex factors such as strike price, contract multiplier, and time decay, making the learning curve steeper.

Leveraged Exchange-Traded Funds (ETFs)

Leveraged ETFs are designed for aggressive investors. These funds claim to be “2x long,” “1x inverse,” etc., achieving leverage effects through derivatives.

However, leveraged ETFs have limitations: when the market trends clearly, their returns are indeed amplified; but during sideways or volatile markets, due to continuous rebalancing mechanisms, their performance can be poor. Moreover, leveraged ETFs have very high trading costs, often 10 to 15 times higher than futures trading costs, making long-term holding costly. Therefore, leveraged ETFs are suitable for short-term trading strategies and are not recommended for long-term investors.

Contracts for Difference (CFD)

CFD has become a mainstream tool on overseas trading platforms in recent years. Its biggest advantage is trading convenience — investors do not need complex financing or margin procedures, only a margin deposit to conduct two-way trading (long or short).

CFD allows investors to trade precious metals, commodities, stock indices, foreign exchange, cryptocurrencies, etc., without owning the physical assets. For example, if a tech stock is priced at 200 yuan, and 10x leverage is set, the investor only needs 20 yuan as margin to establish a position.

However, trading CFDs with leverage requires caution. Investors must pay overnight fees, and regardless of whether they choose 2x or 20x leverage, the platform will automatically set stop-loss points. Once the account loss reaches the set level, the system will close the position automatically, and investors must be aware of the liquidation risk.

How to Use Leverage Rationally

Financial educator Robert Kiyosaki once pointed out that moderate use of leverage can indeed improve investment returns. The key is how to properly utilize borrowed funds to generate continuous cash flow, which is the true value of leverage.

Suggestions for rational use of leverage:

1. Start with low leverage — Beginners should accumulate experience with 2x or 3x leverage, gradually adapting to higher leverage environments, rather than immediately using extreme leverage above 10x.

2. Always set stop-loss — Clearly plan the loss limit, and exit decisively once reached to prevent unlimited losses.

3. Maintain sufficient margin — The higher the margin ratio, the lower the leverage multiple, and the safer the trading. If the account net worth is 100,000 yuan, it is recommended to allocate only 30% to 50% of that in trading assets.

4. Control the size of individual trades — Even with a high account balance, avoid risking too much capital on a single trade; diversify to manage risk.

5. Choose suitable trading tools — For short-term trading, consider futures or CFDs; for long-term investing, stay away from leveraged products.

Leverage itself is neither an absolute remedy nor a destructive force. When investors have sufficient knowledge, strictly implement risk management, and operate within their capacity, leverage can indeed be a powerful tool to enhance returns. However, once out of control or exceeding one’s risk tolerance, its destructive power can destroy the entire investment portfolio.