How to manage risk when trading with leverage

3^rd August 2022

The editorial unit

The editorial unit

3 August 2022

Trading consists of various different components, which need care, skill and knowledge in order to be successful. This is true for one of the most complex methods of trading: leveraged trading.

Trading with leverage has the ability to significantly impact the chances of making a profit, and massively alter the level of risk involved. However, to create a more profitable trading experience, the goal has to be to minimise this risk as much as possible. Despite the complexities of leveraged trading, once one fully understands the fundamentals of the process, it’s possible to begin to implement certain methods to help lower the risk.

Here are some possible ways to make this happen.

What is leveraged trading?

Firstly, leveraged trading allows traders to gain a large amount of exposure to the market, whilst putting down a much smaller deposit of capital. With traditional trading, it’s necessary to deposit enough capital to take ownership of the underlying asset. With leverage, however, the amount needed as a deposit is significantly smaller.

This is most commonly achieved using contracts for difference (CFDs). For instance, say someone wanted to trade Great British Pounds/Confoederatio Helvetica Franc (GBP/CHF) on forex with a leverage ratio of 20:1, it would mean with a deposit (margin) of £1,000, they could trade £20,000 worth of assets. 

How to manage risk with leveraged trading

There are many benefits that leverage trading can bring, yet it’s not without its risks. However, there are many ways to manage that risk effectively:

• Understand leverage fully

One of the best ways to minimise risk is to ensure full understanding of how leverage works, and how the process impacts trades. Leverage can be a great benefit, as it can significantly increase profits when a successful trade is made. Profits are calculated against the leveraged amount, not the amount put down as a deposit – thus enlarging the amount of profit gained.

That said, many traders misunderstand that this process also applies to losses, which are also calculated against the leveraged amount. This means an unsuccessful trade can result in substantial losses compared to the small amount of capital put down. Therefore, it’s worth taking the time to understand the process, so that leveraged trades are executed cautiously and traders avoid being caught by large losses they didn’t expect.

• Apply risk management tools

Expert risk management tools are also essential when leverage trading. Depending on the trading platform chosen, there will be access to a selection of tools designed to help mitigate the amount of loss incurred from trades.

For instance, one of the tools one might find on a platform is the use of automatic orders. These allow certain limits to be set on asset values; should the prices rise above or drop below these limits, the trade will automatically close. This means when a trade starts to move in an unfavourable direction, the trader’s position will automatically close before the loss accumulates to a substantial amount.

• Conduct thorough market analysis

Before executing any leveraged trade, one needs to conduct thorough analysis of the market in order to minimise the risk of an unsuccessful trade.

Market performance is key to establishing the most appropriate trades to make, including what asset to trade, when to open the position, what position to take and how long to hold it for. Once this information is dissected from market analysis, traders can significantly narrow their chances of making an ill-informed trading decision – although, naturally, the market moving against one’s favour is always possible, regardless of analysis.

In any case, as a result of research, a more accurate basis will be established on which to make trades, so that the risk is likely to be much lower.

Leveraged trading can be a great if these tips are considered to help minimise the risk as much as possible. Consequently, chance will be higher for a much more profitable trading journey.

The editorial unit