When you enter the world of financial markets, it is important to know and understand various terms such as financial leverage. We may often hear the word ‘leverage’ in the business and corporate setting but in trading stocks or foreign exchange currencies, it is also quite useful in boosting your capital and potential returns.
Financial leverage is the activity of borrowing additional money in a bid to gain more capital to generate more returns. Most brokers in the trading world offer their respective leverage but other financial instruments such as futures and options work the same way.
To understand financial leverage using figures, let us assume that the famous iPhone maker Apple Inc. will release its iPhone 15 tomorrow. Of course, a lot of people will be anticipating this latest model so you are expecting that the company’s shares in the stock market will rally by 20-30% or more.
Unfortunately, you just found out that there is only $5000 left in your funds to invest in the firm’s stocks. If you win, you will be able to get $6500 in return as profit. But you want to invest more money in the stocks since you are 100% of the stock price surge.
This is where the role of financial leverage comes into play. You can borrow additional $5000, for instance, to double your capital up to $10 000 and buy more shares from Apple. Then after the rally in the stock price had taken place, you can sell your investment at $13 000. From this you can get $7000 as your return after paying the loan of approximately $6000.On the other hand, if the movement of stock prices does not match your prediction, then you may be dealing with multiple losses. This means that financial leverage will be beneficial if you have high level of certainty about the future movement of the shares you invest in.