What is leverage in the stock market?

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Consecuentemente, hay casos de persons que han creado pequeñas fortunas dedicando su vida a la buy-sell movements in the stock market, But there are also many other cases, probably many more, of those people who in the blink of an eye, just as they would have invested their capital in a casino bet, end up seeing their savings or the accumulated resources of many years of hard work and effort.

Those are the two extremes that can be found in this type of business, but undoubtedly there are everything. type of cases and situations that they can count on a certain number of successes and failures that make investing in the stock market an economic activity of various nuances about which nothing is assured.

What is leverage?

In simple terms, Financial leverage consists of a form of investment that refers to the opportunity to manage more money in the markets, of what we really have available at that time. In other words, it is about playing and risking capital that we do not have in liquid form. This is feasible thanks to the fact that there are certain financial instruments that allow us to carry out this type of movement.

It is important to mention that the relevance del apalancamiento financiero In current times it has transcended in such a way that it is not only available in the world of investments, but we can put it into practice, in a basic way, in our daily lives, starting from our daily routine.

A first example with which we can approach what it would be Leverage in practice is credit management and administration., because that is exactly what these services are about, to make a purchase through an amount of money that we do not have available at the time of purchase, and therefore we will make the payment on a monthly basis.

As an example, if you buy a car that is valued at around 20,000 euros, they can arrange a first payment of about 4,000 euros with the car agency and that means that you are leveraging yourself at a rate of 5 to 1, that is, to Si you get a pot, you are putting in a fifth of its value up front, even though you have scheduled the payout in a series of monthly payments.

This first scenario is to clarify how financial leverage can be exercised even in our daily lives without realizing it. In spite of everything, in the case of the stock market, this action acquires a greater implication and, in any case, has more profound effects.

CFD to be able to invest with leverage

About, if we intend to buy a certain amount of shares of a certain company and for a certain amount of money, the numbers are very important to establish the possible losses or gains that we can have for said investment. As an example, through the famous CFDs (contracts for difference), we have the opportunity to buy shares for a value that exceeds our current financial capital, so that we can generate greater profits without having paid an exorbitant amount of money from a time.

In simple terms, Leverage consists of a kind of risk multiplier effect, a financial product with a lot of potential to increase profits quickly, but which is at the same time one of the riskiest investment methods, especially for beginner investors who are just taking their first steps in this type of business, which is why it is not recommended at all for these people.

Therefore, if we plan to obtain about 100 shares of a company that has them at 20 euros each, but we do not have the capital available to make said purchase, which would be about 2,000 euros, the leverage consists of giving the broker a percentage of said sum, which asks how guarantee to be able to leverage it. From this dynamic, you can invest, as an example, the 5% of the original amount of said purchase of shares, which would then be only about 100 euros in total, but under this modality, your profits will be recorded as a number of shares . similar to 2000 euros, and the interesting thing about this procedure is presented with the two main effects that can be derived from it.

The first result that would be expected from the application of a leverage, is based on the possible gains which can be achieved by presenting positive effects, and consists of the following: if we obtain a profit of the 10% with our investment in CFDs, our real profit would not consist of the 10% of our initial investment, which is 100 euros, but of the 10% of the leverage that we made with the broker, that is, the 10% of 2000 euros, which in total represents a profit of 200 euros, from which we obtain a net profit of 100 euros, with which in the end we double it. first amount that we put as an initial investment.

Naked eye this modality can seem quite attractive For anyone who is interested in types of financial movements, but as mentioned previously, it is not recommended that inexperienced people acquire this type of risk, and the reason we will see with the following case that may arise from a leveraged investment.

In the second scenario, the results are not satisfactory because here we are talking about losses and quite large. This negative effect is that if the the stocks we buy fall apart and we take a loss of the 10%, then we will not have lost the 10% of our initial 100 dollars, but the loss will be the 10% of the 2000 dollars that the broker entered through leverage, even if we have never given it to the broker. In this situation, if there is no amount in our account to cover the loss, what happens is that the broker keeps what there is, leaves the account at zero and immediately takes us out of the market.

How to reduce risks when applying leverage?

A very interesting way to reduce the possible losses to a minimum It consists of placing with your broker what is known as a “stop loss”, for which it is important to know the differentiation between invested capital and risk capital, a procedure that consists of the following:

• The invested capital is what we put on the table, that is, when we give our broker about 2000 euros to buy 100 shares at 20 euros each, of a certain company, we are investing those 2000 euros as such, but it does not mean that we have all that amount at stake, because thanks to the stop loss of, we can perform an automatic stop when the value of the stock starts to decline, and this is where the concept of venture capital comes in.
• Venture capital consists of making use of the stop loss of immediately trade our shares as soon as they start to fall to a certain amount.As an example, of the 100 shares that were bought at 20 euros each, to reduce the risk of losses, we can apply a stop loss of to 18 euros, which means that as soon as the value of each share falls from 20 to 18 euros, the 100 shares will be sold automatically, so we will protect ourselves against the opportunity that their value continues to fall rapidly. In this case we will only have lost 2 euros per share, and therefore we will be assuming a real risk of 200 euros, which will be our risk capital of the 2000 that we are invested. Ultimately, it is an effective way to exit the game before the outlook becomes too complicated, because in this business the value of a share can suddenly double, or also fall precipitously until it loses almost all its value.

As we have seen, The use of leverage for investments in the stock market works as one of the most innovative and interesting risk instruments available today., because its intelligent use can generate profits well above those that a normal purchase of shares normally leaves. In spite of everything, it must be taken into account that it is a very risky financial product, which can involve very significant losses and that it must be left in the hands of the most experienced investors, since they are the ones who have the knowledge and resources to face it all. type of unforeseen or economic losses.