Capital market terminology is varied. To trade like an expert investor, you must be familiar with each one. You'll feel like an outsider, and you won't be able to maximize your investment return. This is how you can make the most of leverage in stock market. Let's get into the details about leverage in stock market.
Leverage is basically a tool that a broker or broking company gives to a trader to help them invest in stocks they can't afford. You would increase your purchasing power by using leverage without having to spend more.
You can leverage your borrowing by buying on margin, options and futures. Futures contracts are a high-leverage instrument. Your broker will ask you to pay a margin. Your broker will keep the margin you pay.
Let's look at leverage in the stock exchange using an example. The stock of XYZ company is priced at Rs 100. You earn 50% returns if the stock price rises to Rs 150. You could also use leverage to buy XYZ stock with margin. That is, you borrow Rs 50 and withdraw Rs 50. If the stock price rises to Rs 150, your return will be 100 percent.
However, there are risks. If the stock price drops to Rs 50, it would mean that you have lost Rs 50 if you hadn't fully paid for the purchase. However, if leverage had been used, you would have experienced a loss of 100 percent. Your margin account also will accrue interest, which will be adjusted against your account. A lot of it depends on accurate speculation.
You can't leverage every stock on the market. SEBI maintains a separate list that lists stocks that can be purchased on leverage.
There are a few other things you should keep in mind when using margin.
First, your brokerage may require you to keep a minimum amount.
Another important fact about leverage is the ratio. If someone tells that there is a 2:1 leverage in the stock market, it should be obvious that they can lend you twice as much from their broker.
Another important factor to be aware of is managing risk when margin trading takes place. To plan your exit time from the market, you can use hedging strategies such as stop loss.
Because they protect you against bigger losses and risks, stop-loss can also be used in leverage or margin trading. A stop-loss order allows you to buy or sell stock when the price reaches a certain point. You will need to set up stop loss in futures or options trading so that you can manage your risks.
The stock market's leverage meaning is basically a way to increase your trade returns. However, there are risks associated with leverage like all investment and trading. You can make smart decisions and be balanced in your actions to reap the benefits. Over-leverage can be a problem. Be aware of this. If things go wrong, it can quickly drain your bank account. Be sure to keep track of your positions and use the stop loss function. Don't get carried away.