Leveraged trading is a form of trade that is sometimes known as gearing, or as marginal trading. It works on the same rough principals as the gear in the car, the power from the engine turns the wheels, but the same power in a higher gear turns the wheels faster. Thus with your money, it can make you a profit (or a loss) but through a leveraged trade it can make you greater profits (and therefore, greater losses).
Leveraged trading works through effectively ‘borrowing’ money to add to your investments. This can be done through an intermediary such as a trader, or commonly a spread betting company . It is not usually subject to Capital Gains Tax, which can be a significant advantage.
So how does it actually work? With normal trading you decide to invest a certain amount in some shares in the hope that the share price will rise and you can then sell those shares at that higher price – thus making a profit. If the shares do rise in price by, for example, 10% you will make a 10% profit on your original investment, if, however, they lose value by 10% you will lose only 10% of your original investment, and thus be able to make further investments that will hopefully have more luck.
Now, with leveraged trading you essentially multiply the money at your disposal through an intermediary. This enables you to buy, for example, ten times as many shares as you would originally have done. In the same scenario, a 10% in the value of the shares, will make you no less than 100% profit on your original investment, doubling your money (although, there is, of course, commission and gambling tax to consider), on the other hand, however, if the share price drops by 10%, your losses will also be multiplied and you will lose your entire investment.
Leveraged trading often has a time limit on it, this means that unlike a standard investment, you may not be able to keep hold of your shares and hope that the value rebounds. When it comes to losses, if the share price drops 10% you could lose all your money, but if it drops 20% you will lose all your money, and still owe the broker your entire investment all over again. If the company you are trading in suddenly happens to go completely bust, you will have to pay your own investment and the company’s money back out of your own pocket.
This is why spread betting is such as risk and are keen to make sure their traders are as aware of the risks as possible. Ultimately, though, the choice remains with you, so if you are considering spread betting make sure that you know what you are getting yourself into, that you know how the markets will react in given conditions, and that you do not take unnecessary risks that could end up being extremely expensive.