Gearing, Leverage and Margin

Beginner

In this video and article, we are looking at the concepts of Gearing, Leverage and Margin.

  • Gearing, Leverage and Margin are interconnected concepts in trading.
  • LEVERAGE (also known as Gearing) works by using an effective deposit, known as the MARGIN, to provide you with increased exposure to an asset.
  • A fraction of the full value of your trade is needed, with the account provider/ broker effectively “loaning” the balance.

An example of leverage with Company ABC

Non-Leveraged Account

  • To buy 10 shares in stock ABC at $100 would cost $1,000 without any leverage
  • If stock ABC’s price goes UP to $120, then on the NON-LEVERAGED account the PROFIT would be $20 per share=$200.
  • This is a 20% PROFIT on $1,000

BUT

  • If stock ABC price goes DOWN to $80, then on the NON-LEVERAGED account, the LOSS would be $20 per share=$200. This is a 20% LOSS on $1,000.

Leveraged Account

  • To buy 10 shares in stock ABC trading at $100 with 10% MARGIN on a LEVERAGED account, would only cost $100. This would be 10:1 LEVERAGE.
  • If stock ABC price goes UP to $120, on the LEVERAGED account, the PROFIT would be $20 per share so $200 on $100. This would be a 200% PROFIT.

BUT

  • If stock ABC price goes DOWN to $80, on the LEVERAGED account the LOSS would be $20 per share so $200, but on $100. This would be a 200% LOSS.

So, with LEVERAGE or GEARING the potential losses AND potential profits are increased.

For this reason, leveraged trading on margin has heightened risks and may not be appropriate for all traders and investors.

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