Leverage is best explained using an example.
Unleveraged shares vs spread betting with leverage
Betting with leverage means your profit or loss will be much greater than your initial investment
Let’s say you have £1000 to invest. Traditionally, you might approach a stockbroker and use your money to buy 1000 shares in a company trading at 100p per share. Your exposure here is £1000, and for every penny, or point, the share price rises/falls, you make/lose 1000 x 1p = £10.
Importantly, the most you can possibly lose in this case is £1000 (should the share price fall to zero).
If, on the other hand, you had gone to a spread betting provider offering, for instance, 20:1 leverage on the same shares, you could have gained the equivalent exposure for a deposit, or margin, of just £50. This would be enough to open a bet worth £10 per point – such that for every point the share price rises/falls, you make/lose £10.
Leverage of 20:1 means that a deposit of £1 gives you £20 exposure in the underlying market.
Another more risky, but potentially more profitable, approach would have been to use your entire £1000 as margin to open a single bet worth £200 per point, or giving you exposure of £20,000 in the underlying market.
If you had done this, each point of movement in your favour would generate 20 times as much profit compared to the unleveraged scenario – for the same initial outlay.
But the same is true for your potential losses. The market would only have to move against you by five points to wipe out your entire £1000 ‘investment’.
And should the market move extremely quickly, or 'gap' suddenly between two prices, you could potentially lose an awful lot more. In the absolute worst case scenario, with the underlying share price falling to zero and neither you or your provider being able to close the position, you would lose your full exposure of 100 x £200 = £20,000.
How much leverage can you get?
You’ll find the degree of leverage you can get will vary according to the conditions of the underlying market, the size of your bet, and what your provider is willing to offer.
Generally speaking, the more volatile or less liquid an underlying market – or the larger your bet – the lower the leverage on offer, as providers seek to protect you, and themselves, from the effects of large and rapid movements in price.
It’s not unusual to find leverage of 200:1 offered on extremely liquid markets, like popular forex pairs, and some providers may even go so far as 400:1.
Here’s how different degrees of leverage affect your exposure (and thus profit potential and maximum loss) for an initial investment of £1000:
|Unleveraged trading||Spread betting with leverage|
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