When the conversation is about leverage in trading, many texts and blogs tend to look at it from the standpoint that it is very dangerous and should be avoided. You’re almost certain to see or hear the phrase “double-edged sword” somewhere in the discussion. But, is it really true? What about professional traders? Do they use leverage?
Professional traders do use leverage but are very disciplined and conservative with using it. Typically, depending on the asset class, the maximum leverage that professional traders use would range between 1:10 and 1:30. Contrarily, inexperienced retail traders have a tendency to use much higher leverage.
In this article, I’ll look at everything you need to know about leverage (including the pros and cons) and why professional traders embrace it instead of running away from it.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Is Leverage? How Does It Work?
In trading, leverage is a feature that allows you to have control over more units of any asset than your trading balance would typically allow.
For example, if a broker offers 1:100 leverage, it means that for every $1 in your account, you can control $100 worth of trading positions. This means you can open a position worth $100,000 with only $1000 in your trading account!
Trading without leverage means you have enough cash in your account balance to cover the complete investment requirements for any open position in full.
The Advantages of Leverage
Some of the advantages of leverage in trading include the following:
Faster Account Growth
With leverage, you can speed up the returns on profitable trades.
For example, if you have $1000 and trade without leverage, making 5% on the entire balance will net you $50. If you use leverage and get to control 10-200 times your $1000 balance, your profit increases exponentially to $500-$10,000.
Leveraged trading is why the few successful retail traders can transform a trading account with a few hundreds of dollars in it into healthy five-figure sums.
More Flexibility in Trading
Without leverage, you’re sure to have very little wiggle room in the assets you can trade. Most brokers have different margin requirements for stocks, cryptocurrencies, currencies, metals, indices, and commodities. With little or no leverage, many traders can only trade currencies and some non-volatile stocks.
Lower Barrier to Trading
Leveraged trading is why many people can now start trading all kinds of assets with $500 or less. Before it became popular, you’d need tens of thousands to join a brokerage. Today, traders can enjoy up to 1:50 leverage in the US and up to 1:2000 leverage at offshore brokerages. This means you can trade with just about any amount you can afford.
The Disadvantages of Leverage
Leverage can be very useful, but like most things in this industry, it has its downsides:
Faster Account Loss
Many traders use leverage irresponsibly. They often max out the margin requirements, exposing themselves to a margin call.
Although this can also happen without leverage, such traders will be less likely to take unnecessary risks in the first place if they have to work with small amounts. Sometimes, parking the money in a bank can yield better returns.
So, leverage draws in retail traders with small accounts, but the irresponsibility it can encourage quickly leads to margin calls and a lost account.
Poor Trading Behavior
New leveraged traders with the freedom to trade virtually any asset end up exploring virtually every asset available with a broker. Some jump in and out of positions based on calls on social media. They spend very little time understanding the peculiarities of the specific instrument.
With little or no leverage, traders often have to stick to the same group of assets they understand very well—assets with margin requirements and volatility that align with their account balance.
Why Do Professional Traders Use Leverage?
Professional traders use leverage because it reduces the financial requirement for holding certain positions. For example, if the trading balance only holds $1,000,000 and the trader needs to control positions worth $10,000,000 to reach their trading objectives, it makes sense to look for 1:10 leverage at the minimum.
How Do Professional Traders Use Leverage?
Professional traders treat leverage as just another tool.
They first look at the assets they trade and the margin requirements as well as the potential number of open trades they are likely to have at any one time. Then they choose a leverage level that allows them to stay within their risk management parameters.
For example, a professional trader who risks 1 percent per trade entry and only has 5-15 trades open can choose a 1:30 leverage to ensure adequate wiggle room for all open positions and avoid any margin calls. So, instead of choosing leverage first before working out their risk management, they work out the latter first before settling on any specific number as leverage.
For most professional traders, the max leverage on offer for any broker doesn’t matter as long as it is enough to cover what they regard as their minimum.
So, even when a professional trader moves to a broker that offers 1:1000 leverage, they won’t deviate from their risk profile. Of course, they’ll have lots of free margin, but that doesn’t change much.
This is in contrast to how typical retail traders use leverage. They often go for the highest leverage on offer, then keep opening positions until they’ve maxed out their margin or use a large trade size on one position. This is an attempt to make as much money as possible from the expected move.
When it works, the trader can easily double or triple their trading balance. However, it doesn’t always work out. A normal losing trade can end up turning into a margin call and a zero balance.
Do All Professional Traders Use Leverage?
Not all professional traders use leverage. As the trading balance increases, the number of brokers and liquidity providers that can offer leverage will fall.
You can find offshore brokers offering leverage of up to 1:2000 on accounts smaller than $1000. As the balance on the account grows to $20,000, that number will fall sharply to 1:100. The absolute maximum leverage available in the US is 1:50 for forex, 1:15 for futures, and 1:5 for stocks.
Beyond $500,000, you’re unlikely to find brokers offering more than 1:30 leverage—both in the US and abroad. Professional traders controlling hundreds of millions don’t use leverage. Even if they’d like to, no brokers will take them on.
What Are the Lessons for Retail Traders on Using Leverage?
The main lesson retail traders can learn from how professional traders use leverage is that there’s no need to choose the highest leverage available from a broker. Just because you can use it doesn’t mean you should.
You can stick to just enough leverage you need to stay profitable in line with your trading system and risk management. Even when you’re on an account that allows 1:200 leverage, you don’t need to throw your risk profile out of the window and start trading larger sizes.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
- Best Trading Courses You Can Take For Free (or at extremely low cost): I reviewed 30+ trading courses to recommend you the best resource, and found Trading Strategies in Emerging Markets Specialization on Coursera to beat every other course on the market. Plus, if you complete this course within 7 days, it will cost you nothing and will be absolutely free! Click Here To Sign Up Today! (If you don’t find this course valuable, you can cancel anytime within the 7 days trial period and pay nothing.)
- Best Passive Investment Platform For Exponential (Potentially) Returns: By enabling passive investments into a Bitcoin ETF, Acorns gives you the best opportunity to make exponential returns on your passive investments. Plus, Acorns is currently offering a $15 bonus for simply singing up to their platform – so that is one opportunity you don’t want to miss! (assuming you are interested in this platform). Click Here To Get $15 Bonus By Signing Up For Acorns Today! (It will take you less than 5 mins to sign up, and it is totally worth it.)
Conclusion
Professional traders use leverage up to a certain level. How much leverage they’ll use is determined by their risk profile and the peculiarities of the asset classes they trade.
Heavily funded professional traders don’t use leverage partly because they can afford to put down the margin required to hold their positions and also because it’s hard to find liquidity providers offering leverage beyond a certain capital base.
Retail traders can emulate how professional traders use leverage by paying more attention to their risk profile instead of using the highest leverage on offer and opening the largest trade sizes allowed.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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