The capital market is full of interesting terminologies. As an investor, you need to update yourself on each of them to trade like an expert. Otherwise, you’ll always feel like an outsider and fail to optimise your profit from an investment. So, when we explain to you what leverage in stock market is you can use this knowledge to your advantage. Without further ado, let’s understand in detail, what is leverage in stock market?
So, basically, leverage is something a trader is given by the broker or broking firm so he or she can use it to invest in a stock that they wouldn’t be able to afford on their own. So, if you were to use leverage, you would be increasing your purchasing capacity, without spending additionally from your pocket.
Some examples of leverage are buying on margin, futures and options, and you are using leverage trading when you borrow so you can gain more. Futures contracts, for instance, are very high leverage instruments. It involves a large amount, and so, your broker asks you to pay only a margin for the deal. The margin you pay will be held by your broker.
Let’s discuss leverage in the stock market with an example. You buy XYZ company’s stock priced at Rs 100. If the price goes up to Rs 150, you earn 50 per cent returns. On the other hand, you could use leverage and buy XYZ stock on margin, i.e., you use Rs 50 from your pocket and borrow the remaining, and if the stock price goes up to Rs 150, your return is 100 percent.
But it also has risks involved. If your stock price falls to Rs 50, then if you had fully paid for it, you would have lost Rs 50. On the other hand, if you had used leverage, you would have lost 100 per cent. On top of that, your margin account will also incur interest which will also get adjusted against your account. So, a lot depends on correct speculation.
However, you can’t use leverage on each and every stock in the market. SEBI has a separate list of stocks mentioning the ones that can be bought on leverage.
Also, there are few other things to keep in mind while using margin.
Firstly, you may be required to maintain a specific amount as minimum balance, as required by your brokerage firm.
Another important fact is that leverage is often expressed in terms of a ratio. So, if someone tells you about a 2:1 leverage in stock market, you should surmise that you can borrow double the amount of your intended investment from your broker.
Managing risk during margin trading is another crucial factor to consider. You can use hedging techniques like stop loss to plan the right exit time from the market.
Stop-loss can be used in margin or leverage as well like regular trading because they can protect you from bigger losses or risks. Stop-loss order helps you buy or sell a stock once the price touches a specific point. In futures and options trading too, you would need to set up the stop loss feature so you can manage the risks.
Leverage meaning in stock market is essentially a chance to pump up the returns on your trade. But it also has risks involved, like everything else in the world of trading and investment. If you are smart and balance your moves, you can benefit. There is always the problem of being over-leveraged, so be wary of that. It can quickly drain your account if things go wrong. So, make sure you track positions, use the stop loss feature and don’t get carried away.