Leverage is derived from margin trading. It is derived from the fact that during a transaction, both the buyer and the seller pay a margin and each guarantees to the other party to fulfill the future contract. Since the margin is mostly calculated as a proportion of the total contract amount, this ratio is the leverage.
In the financial market, many traders will provide this kind of margin trading service arrangement, such as mortgage lending, or some derivative products involve leverage. Generally, this is to facilitate smaller investors and make it easier for them to enter the market for trading. However, in fact, it is not entirely. The leverage arrangement is essentially for some financial assets with small fluctuations, but involves larger transactions.
The foreign exchange market is more often traded with leverage because the average daily volatility of the foreign exchange market is not large. Under normal market conditions, the fluctuation of most major currencies is less than 1%. Investors, brokers and banks all believe that transactions do not require full payment, and through the method of margin, the settlement of the contract can be ensured.
It is not difficult to find that leverage arrangements are not common for individual assets, non-mainstream stocks, currencies, etc. Or once market conditions become unusual, banks and brokers will lower leverage multiples to ensure orderly transaction settlement.
In short, leverage can be both good and bad. Investors can use their funds more efficiently, which means they have more flexibility than without leverage, and can make full use of their funds to capture other investment opportunities, or increase investment efforts to maximize profits in market conditions with good opportunities.
However, while profits can be magnified, losses can also be magnified when the direction is wrong. Some investors may have poor fund management, resulting in insufficient margin and prone to margin calls. Furthermore, once a special market condition occurs and the market fluctuates violently, such as the so-called "flash crash", investors' positions may suddenly be forced to close at an extremely undesirable price. It should also be noted that leverage involves the dealer's lending arrangements, and most of them will imply financing fees in the transaction.
All financial products traded on margin carry a high degree of risk to your capital. They are not suited to all investors and you can lose more than your initial deposit. Please ensure that you fully understand the risks involved, and seek independent advice if necessary.