Understanding Leverage Completely: From Usage to Risk Management

Spot trading alone has limitations due to physical capital constraints. However, by utilizing leverage, you can open positions much larger than your assets, significantly increasing profit opportunities. Of course, this also amplifies losses. In this article, we will take a detailed look at the mechanism, actual effects, pros and cons, and successful risk management strategies of leverage trading.

Core Concepts of Leverage Trading

Derived from the words leverage(leverage), leverage is a technique of borrowing funds from a broker to conduct trades larger than your original capital. Just like a lever lifts heavy objects with minimal effort, you can open large positions with a small amount of capital.

For example, with an initial capital of 1 million won, using 10x leverage allows you to trade with a 10 million won position. This is possible because the broker lends you 9 million won.

Margin and Leverage Multipliers

To understand leverage trading, two key elements must be grasped.

Margin(Margin) is the collateral you deposit to maintain a position. It proves to the broker that you have the ability to cover potential losses during trading. The required margin size varies depending on market volatility, asset type, and position size.

Leverage multiplier indicates the ratio of trading funds relative to the margin. A 10:1(10X) ratio means you can trade 10 times the amount of your margin. Higher multipliers allow larger trades with less initial capital but also increase the speed of loss amplification.

For example, with a 50:1 leverage, a 1% price drop results in a 50% loss. In contrast, in spot trading without leverage, a 1% decline results in only a 1% loss.

Actual Effects of Leverage Trading

The most distinctive feature of leverage is that it amplifies both profits and losses simultaneously.

Profit Amplification Example

Suppose you have 1 million won in capital and open a position with 10x leverage. If the price rises by 1%, what happens?

• Without leverage: 1 million won × 1% = 10,000 won profit
• With 10x leverage: 10 million won × 1% = 100,000 won profit

The same 1% increase yields a 10-fold profit difference.

Loss Amplification Example

Conversely, if the price drops by 1%:

• Without leverage: 10,000 won loss
• With 10x leverage: 100,000 won loss

Even small price movements can lead to significant losses. The risk becomes more severe when the price drops sharply. Using 20x leverage, a 5% decline results in a loss equal to your initial capital (100%). This triggers a margin call(additional margin request from the broker), and if not met, the position is forcibly liquidated.

Leverage Trading vs. Spot Trading

These two methods have clear differences.

Features of Spot Trading

Spot trading involves owning the actual asset, with profits or losses limited to the asset’s price movement. If you invest 1 million won, your maximum loss is 1 million won. It is psychologically less burdensome for beginners and advantageous for long-term holding strategies. However, it is difficult to significantly increase trading size with the same capital.

Features of Leverage Trading

Leverage trading allows for substantial profits from small price movements. It offers high capital efficiency, making it easier to diversify a portfolio with limited initial funds. It is especially suitable for short-term trading. However, losses can exceed the initial investment, and there are risks of margin calls and high psychological stress.

Is Leverage Trading Suitable for Me?

Before starting leverage trading, objectively assess your situation.

Suitable Traders for Leverage Trading:

• Those who understand market mechanisms well
• Those with strong psychological resilience to losses
• Those capable of implementing effective risk management
• Those with extensive short-term trading experience
• Those with assets to cover potential losses exceeding initial investment

Conversely, if you fall into the following categories, it is recommended to start with spot trading:

• Beginners lacking market understanding
• Those who cannot tolerate significant losses
• Traders operating in highly volatile or illiquid markets
• Those with limited capacity to absorb losses

Summary of Pros and Cons of Leverage Trading

Advantages

• High profit potential: Achieve noticeable gains with small price movements
• Capital efficiency: Open multiple positions with small amounts
• Access to high-value assets: Trade assets otherwise unaffordable
• Hedging: Use insurance positions to mitigate risks cost-effectively
• Portfolio diversification: Invest in more assets with the same capital

Disadvantages

• High loss risk: Losses are amplified along with profits
• Margin call risk: Forced liquidation if margin is insufficient
• Volatility risk: Vulnerable to rapid market swings
• Trading costs: Accumulated interest and swap fees on borrowed funds
• Psychological burden: Excessive stress can impair judgment

Practical Tips to Reduce Losses in Leverage Trading

Effective risk management is crucial for success in leverage trading.

1. Always set stop-loss orders

Before opening a position, determine your stop-loss level. Setting a stop-loss order automatically closes your position at a specified price, controlling potential losses.

2. Optimize position size

Adjust your position size according to your capital and leverage to prevent a single loss from jeopardizing your entire portfolio. Generally, do not risk more than 1-2% of your total capital on a single trade.

3. Diversify your portfolio

Invest simultaneously across multiple assets and markets to mitigate the impact of individual losses.

4. Monitor the market

Check daily market conditions, trends, and potential risk signals. Early detection enables quick responses.

5. Use trailing stops

After profits are realized, setting a trailing stop can lock in gains while preventing losses from sudden reversals.

6. Avoid excessive leverage

Especially in volatile markets, lower your leverage. Extreme ratios like 50x or 100x can lead to rapid losses.

7. Keep a trading journal

Record reasons for entry, outcomes, and lessons learned for each trade. Regular analysis helps improve trading patterns.

Instruments Utilizing Leverage

Forex Trading

Currency fluctuations are relatively small, requiring high leverage (over 100:1) for short-term gains. Many forex traders use leverage above 100:1 for this reason.

CFD (Contract for Difference)

Allows profit from price movements without owning the underlying asset. Using leverage enables large trades with small capital, often used for short-term trading.

Futures

Contracts to buy or sell assets at a predetermined price in the future. Leverage transforms small price changes into significant profits.

Options

Contracts granting the right, but not obligation, to buy or sell an asset at a set price. When combined with leverage, options enable large-scale trades with minimal capital.

Conclusion

Leverage trading is a powerful tool but also a dangerous double-edged sword. While it offers high profit opportunities, losses can be swift and substantial. It is wise to start with spot trading to understand the market, develop risk management skills, and then gradually move into leverage trading.

Assess your experience level, risk tolerance, and market understanding objectively before deciding to engage in leverage trading. Beginners are advised to build a foundation with spot trading and only venture into leverage once they have gained sufficient experience.