Understanding leveraged trading: from basic concepts to practical risk management

Leverage trading is ubiquitous in modern financial markets. Many investors have been exposed to margin trading or futures trading, hoping to amplify returns through leverage. However, this double-edged sword is equally dangerous—once the market moves against you, profits can evaporate instantly, and even your principal may be entirely lost.

What is leverage trading? Core concept analysis

The essence of leverage trading is borrowing money to invest. Investors use a smaller amount of their own funds as margin and borrow funds from brokers or platforms to control larger assets. The purpose of this approach is simple—maximize gains with minimal capital.

For example: You have NT$100,000 of your own funds, and borrow NT$900,000 from the platform, making the total investment NT$1,000,000. This creates a 10x leverage. Theoretically, if the investment gains 10%, you don’t earn NT$10,000 but NT$100,000.

Common leverage tools include:

• Margin buying stocks: Borrow money from brokers to buy more stocks
• Using derivatives: Futures, options, CFDs, which have built-in leverage mechanisms
• Corporate level: Companies leverage through debt financing

Famous investor Robert Kiyosaki once pointed out that loans are not always bad. When properly utilizing mortgage loans for financial management, reinvesting to generate cash flow, and turning liabilities into assets, that is the true art of leverage.

Leverage vs. Margin: Looks similar but fundamentally different

Many people confuse leverage and margin, but they are indeed different concepts:

Leverage represents taking on debt, while margin is the collateral funds an investor must pledge to hold a position. Margin is the foundation of leverage operation, but margin itself is not leverage.

Taking Taiwan index futures as an example, understanding the leverage mechanism:

Suppose the recent closing price of Taiwan Futures is 13,000 points, with each point worth NT$200. The total contract value is: 13,000 points × NT$200/point = NT$2,600,000

In futures trading, investors do not need to pay the full NT$2,600,000 upfront, only the margin (say NT$136,000). The leverage multiple is calculated as: NT$2,600,000 ÷ NT$136,000 ≈ 19.11 times

This means controlling NT$2.6 million worth of assets with NT$136,000.

The double-edged sword of leverage: profits and losses are magnified

Profit scenario: If the Taiwan Futures index rises 5%

• Profit = (13,650 - 13,000) × NT$200 = NT$130,000
• Using NT$136,000 capital to earn NT$130,000 yields nearly 96% return

Loss scenario: If the index drops 5%

• Loss = (13,000 - 12,350) × NT$200 = NT$130,000
• Almost all of the principal is lost

From this, it’s clear that higher leverage multiples significantly amplify both potential gains and risks. That’s why investors should increase margin ratios, reduce leverage multiples, and thus lower trading risks. Setting strict stop-loss points to control losses is also crucial.

Complete overview of leverage trading tools

There are four main types of investment tools available for leverage, each with its characteristics.

( Futures: Standardized contracts, traded on centralized exchanges

Futures are agreements where both parties commit to buy or sell at a predetermined price at a specific future date. Trading occurs on futures exchanges, using standardized contracts. Many multinational companies also hedge risks through futures.

Common futures include:

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

Futures contracts specify the underlying asset, price, and expiration date. Traders can close or roll over positions before expiry. At settlement, contracts are settled at the spot market price, which means sharp fluctuations in the spot market can lead to unpredictable settlement prices and risk.

) Options: Flexible choice rights

Options give the buyer the right, but not the obligation, to buy or sell the underlying asset at a predetermined price within a specific timeframe. Compared to futures, options offer more flexibility. Investors can choose whether to exercise their rights based on market movements, with relatively controlled risk.

( Leveraged ETFs: Short-term trading tools

Leveraged ETFs are special products within index funds, commonly called “2x leveraged ETFs,” “inverse 1x ETFs,” etc. These funds are suitable for more aggressive investors.

Note that leveraged ETFs perform magnified in clear trending markets but underperform during sideways or volatile markets. They are mainly used for short-term strategies. Additionally, trading costs for leveraged ETFs are higher, often 10-15 times that of futures trading, so investors should evaluate cost-effectiveness.

) CFDs: Flexible two-way trading

Contracts for Difference (CFD) allow traders to easily go long or short without holding the actual asset or dealing with complex margin procedures, unlike futures which have settlement dates.

CFDs are not standardized contracts and are not traded on centralized exchanges. Different platforms offer varying trading conditions, with more diverse products and flexible contract specifications. Using margin, investors can trade a wide range of global assets, including stocks, precious metals, commodities, indices, forex, and cryptocurrencies.

For example, if Amazon’s stock price is USD113.19, with 20x leverage, you only need to put up USD5.66 to trade one share.

Advantages and disadvantages of leverage trading

Advantages

Enhanced capital utilization: Leverage allows small investors to make large trades with less capital, significantly reducing transaction costs and improving capital efficiency.

Increased profit multiples: Without leverage, NT$100 can only buy NT$100 worth of assets. With leverage, NT$100 can control NT$1,000 or even NT$10,000 worth of assets, multiplying profits accordingly.

Disadvantages

Significantly increased risks and higher liquidation probability: The higher the leverage, the larger the position size. Under the same loss percentage, high-leverage accounts face a much higher risk of liquidation than low-leverage accounts.

Losses are amplified: When trading incurs losses, leverage also magnifies the loss magnitude. This means small losses can quickly deplete the principal, making risk management and timely stop-loss essential.

Risk warning for leverage trading

The most frightening aspect of leverage trading is the “liquidation” or “margin call” phenomenon. When investors cannot quickly cover their losses, platforms will forcibly close positions to prevent further losses.

There are many tragic cases. For example, a Korean YouTuber in 2022 livestreamed crypto futures trading, using 25x leverage to long Bitcoin at USD41,666. When Bitcoin fell below USD40,000, he added more leverage, ultimately losing over USD10 million within hours.

This brutal lesson reminds us that abusing uncontrollable leverage and immature trading strategies is deadly. Investors must be fully prepared for market volatility, avoid over-leverage and overconfidence. Setting stop-loss points to control losses is a must for every leveraged trader.

Practical advice for leverage investing

No matter which leverage tool you choose, using leverage means borrowing funds, and the risk of liquidation always exists. Whether 1x or 20x leverage, always set a stop-loss in advance.

Robert Kiyosaki believes that moderate use of leverage can indeed increase returns, but the key is how to properly use borrowed money to grow wealth. After leveraging, both risks and returns multiply, especially with high-volatility products, which can lead to rapid liquidation.

Start practicing with low leverage ratios, and always remember the stop-loss principle. Leverage itself is not evil; if used to increase returns under risk control, it can be a powerful tool. The critical factors are the investor’s risk awareness and disciplined execution.