Before being able to understand what day trading leverage is, you should first find out what leverage is. Most dictionaries define financial leverage as the use of a small initial investment, credit, or borrowed funds to gain a very high return, to control a much larger investment, or to reduce one’s own liability for any loss.
Trading using leverage is basically trading on credit, by depositing a small amount of cash, and then borrowing a larger amount of cash. Day Trading leverage practices can be applied to stocks, stock options, currencies, futures and commodities.
Example: A trade on the EUR futures market has a contract value of $125,000. But by using leverage, the same trade can be made with only $6000 in cash. Leverage is related to margin, in that margin is the minimum amount of cash that you must deposit in order to be allowed to trade using leverage. Thus, $6000 is the margin required to make the trade in this example.
It depends on your trading opportunity to determine how much leverage you are able to get from your investments. Below is an example of the differences between using cash trading and leverage trading:
Stock Trade Sample
• Symbol: ZYX
• Trade: Long 1000 shares
• Tick Value: $10 per 0.01 change in price
• Entry Price: $125.50
• Target: $126
• Stop Loss: $125.25
If the above trade is traded using cash, the trader would need $125,500 to enter the trade. If the trade was profitable (i.e. it reached its target), they would make a profit of 50 ticks, and receive $500 (50 ticks x $10 per tick) in profit. If the trade was not profitable (i.e. it reached its stop loss), they would lose 25 ticks, thereby losing $250 (25 ticks x $10 per tick) of their original capital.
If the same trade is traded using leverage, the trader would only need $37,650 in cash in order to enter the trade. If the trade was profitable (i.e. it reached its target), they would make the same profit of 50 ticks, and still receive $500 (50 ticks x $10 per tick) in profit. If the trade was not profitable (i.e. it reached its stop loss), they would still only lose 25 ticks, thereby losing the same $250 (25 ticks x $10 per tick) of their original capital.
All in all, Day trading leverage is an efficient use of capital and which is no more risky compared to trading on cash.
