Introduction to Financial Leverage: How Leveraged Trading Amplifies Gains and Risks

Leverage trading is not unfamiliar in the stock market; many investors have explored margin trading or day trading. The core logic of financial leverage is simple: using borrowed money to invest, thereby leveraging a smaller principal to control a larger trading volume. It sounds enticing, but the hidden risks can easily lead many to lose everything.

What is leverage trading? How does financial leverage work?

The essence of leverage trading is borrowing to invest. Suppose you have 100,000 yuan of your own funds, borrow 900,000 yuan from a broker, and conduct a total transaction of 1 million yuan. This is called 10x leverage.

Here’s a more intuitive example: assume the recent closing price of Taiwan index futures is 13,000 points, with each point worth 200 yuan. The total value of one Taiwan index futures contract is 2,600,000 yuan. But you don’t need to pay the full amount; just a margin (say 136,000 yuan) is required to control this asset. At this point, the leverage ratio is approximately 19.11x, meaning that with 136,000 yuan, you can control assets worth 2.6 million yuan.

This approach seems to effectively increase capital utilization, but the risks also multiply accordingly. If the Taiwan index rises by 5%, as in the example above, you could earn 130,000 yuan, which is a 96% return on the 136,000 yuan principal. Conversely, if it drops by 5%, you would lose 130,000 yuan, nearly wiping out your entire principal.

The risk mechanism behind financial leverage

Many young investors mistakenly believe that “winning yields huge profits, and a margin call doesn’t require additional funds,” but in reality, this mindset often results in painful losses. When the market fluctuates violently and investors cannot promptly meet margin requirements, brokers will forcibly liquidate positions to prevent their own losses, a process known as a “margin call” or “liquidation.”

A real case worth noting: a Korean YouTuber named Satto once conducted high-leverage Bitcoin futures trading during a live stream. He opened a 25x long position when Bitcoin was at $41,666, betting that BTC would rise. When Bitcoin fell below $40,000, he not only failed to cut losses but continued adding to his leveraged long positions, ultimately losing over $10 million within hours. This case clearly illustrates that abusing uncontrollable leverage combined with immature trading strategies is a deadly combination.

Diversified leverage tools

Futures trading

Futures are contracts where both parties agree to buy or sell at a predetermined price at a specific future date. The futures market covers multiple categories:

• Metals: Gold futures, silver futures, aluminum futures, etc.
• Indices: Dow Jones Industrial Average, S&P 500, NASDAQ, Hang Seng Index, etc.
• Agricultural products: Wheat, soybeans, cotton futures
• Energy: Crude oil, natural gas, coal futures

Futures contracts are highly standardized, traded mainly on futures exchanges, but at settlement, they face the unpredictability of spot market price fluctuations.

Options trading

Options give the buyer the right, but not the obligation, to buy or sell an asset at a specific price within a certain period. This flexibility makes options a choice for more advanced investors.

Leveraged Exchange-Traded Funds (ETFs)

In the ETF market, products like “2x leveraged ETFs” and “inverse 1x ETFs” are common. These are leveraged ETFs suitable for active traders in the short term. However, their biggest weakness is high trading costs—up to 10 to 15 times those of futures trading—which can erode returns over the long term.

Contracts for Difference (CFD)

CFDs allow traders to engage in two-way trading (long or short) via margin, without holding the actual asset, and are not limited by settlement dates. The scope of trading includes stocks, precious metals, commodities, indices, forex, cryptocurrencies, etc., with flexible contract specifications.

Pros and cons of financial leverage

Advantages: Increasing capital efficiency is the main attraction of leveraged investing; small amounts of capital can participate in large trades. Additionally, leverage can multiply profits—trading $100 worth of products worth $1,000 or even $10,000 can significantly amplify returns when profitable.

Disadvantages: The higher the leverage, the greater the risk of liquidation. Once losses occur, the magnified effect of leverage can cause losses far exceeding expectations. Therefore, proper risk management and timely stop-loss are essential.

How to use leverage trading healthily

Investment expert Robert Kiyosaki emphasized that moderate use of leverage can be a tool to increase returns, with the key being how to properly utilize borrowed funds to build wealth. Here are some suggestions:

• Start with low leverage: Avoid using high leverage initially; get familiar with the market with lower ratios.
• Always set stop-loss points: No matter how much leverage is used, stop-loss discipline is non-negotiable.
• Prepare sufficient funds: Before engaging in leveraged trading, ensure you have enough margin to withstand market volatility.
• Avoid overconfidence: High-volatility products combined with high leverage often lead to rapid liquidation.

Leverage itself is neither inherently good nor bad. If used under proper risk control to increase returns, it can be beneficial. But investors must fully understand the mechanics of financial leverage, master trading strategies, and always stay vigilant.