There are various components involved in trading of any kind. Therefore, it’s essential that you fully understand and familiarize yourself with each of these. Knowing how to effectively handle these aspects of trading is what gives you the best chance of profit and success throughout your entire trading journey. Among them. Arguably one of the most important components to understand in trading is dynamic leverage. Read on to learn all about what dynamic leverage is, how it works, and how it can benefit your trades.
Before learning what dynamic leverage is, you must first understand leverage. Leverage in trading allows investors to gain greater exposure to the market, with a significantly smaller amount of capital.
With traditional trading, you have to deposit the full amount of capital to take ownership of the underlying asset. With leverage, however, you don’t need to take ownership. Instead, you put down a much lower deposit which can be magnified with leverage.
For example, if you wanted to invest in the AMC Entertainment share, your initial deposit of capital can be multiplied by a specific amount. With this you get greater exposure to the market. Thus, your returns will be equally amplified.
Leveraged trading is usually done using financial derivatives which don’t require ownership of the underlying asset. For example, trading contracts for difference (CFDs). In this instance, you purchase contracts on an asset that speculate on its price movement. Using leverage, the capital you put down can allow you to purchase a significantly higher number of contracts than you would be able to without leverage.
The specific amount that your capital increases by will be determined by the leverage ratio. For example, a leverage ratio of 30:1 would mean that a deposit of only £100 could allow you to trade up to £3,000 on an asset.
As a result, your returns will calculate against the £3,000 leveraged amount, not the £100 deposit. This is important to realize, as on the one hand it means you have the potential to substantially increase your profits. However, this will work the same for your losses in any unsuccessful trades too.
Therefore, make sure you are highly aware of the risks and rewards involved in leveraged trading. This can give you the best chance of making a profit in each of your trades, and help you trade responsibly.
Dynamic leverage is a mechanism that’s used to adapt the amount of leverage based on your specific trade position.
As above, the amount of leverage for your trade is based on the leverage ratio. This measures the total exposure compared to the capital needed, also known as a margin. With dynamic leverage, this ratio automatically adjusts depending on the volume of your trade. Thus, the higher the volume of your trade, the lower the leveraged amount – and vice versa.
For example, if you wanted to trade CFDs on a particular asset, the more contracts you purchase, the lower the amount of leverage you can gain. A volume between 0 – 100,000 might have a leverage of 1:100. However, a volume between 100,000 – 200,000 might have a leverage of 1:5.
The purpose of dynamic leverage is to act as a form of risk management for traders. Higher amounts of leverage create more risk for the investor. Larger profits but also larger losses. Therefore, the more capital you deposit on a trade, the less risk you might want to have.
Therefore, as your trades increase in volume, dynamic leverage will automatically lower the leverage you receive. This means that your trades remain responsible and you can manage your risks.
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If you’re a trader who often uses leverage, or wants to start incorporating it into your trades, consider the benefits of dynamic leverage. After all, it can help you better manage your trade risk and profits.
