Leverage

Leverage means borrowing funds to boost returns from an investment. Investors use leverage to multiply their power in the market. Companies, on the other hand, use leverage to increase their shareholder's return.

How can I use leverage when trading stocks?

You can engage in stock leverage trading (also called margin trading) by borrowing money from your broker to increase your position size. For example, let's say you want to buy 100 shares of Apple that are trading at $116.60 per share. This means that you will need to put in an initial principal capital of $11,660. However, you only have $5,000, so you decide to borrow another $6,660 from your broker to meet the $11,660 initial investment. After one year, Apple's stocks grew by 20% to $139.92 per share. Your total profit will be $2,332, and after returning the $5,000 to your broker, you will have made 79.8% returns on your initial principal sum of $5,000, almost four times more than the returns that Apple's stock price has gained.
However, the reality is not so simple, and leverage is a double-edged sword: you can gain more, but you can lose more, too. Let's take the same example. If instead of earning 20%, Apple's stocks fell by 40% after one year due to unforeseen market turmoil. You will have lost $4,664, and after returning the $5,000 to your broker, you will have made a 60.08% loss on your initial investment amount of $5,000, more than 1.5 times more than the losses Apple's stocks incurred. You should also bear in mind that for the entire duration of trading stock on margin, you'll pay additional fees (often hidden), interest, and commission.
Instead of trading using leverage yourself, you might want to invest in hedge funds as they often use high leverage strategies. Hedge funds are known for their aggressive investment strategies that seek to consistently outperform the market by using a combination of long-only or long-short strategy. Some hedge funds even utilise statistical and mathematical tools and algorithms to engage in short-term trades that achieve astounding returns.

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A

Assets

Valuable resource that someone owns with the expectation that it will provide some future benefit.

Accounts Payable

Value that represents a company's obligation to pay off short-term debts to its vendors, creditors, or suppliers.

B

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C

Cost of Goods Sold

Refers to all of the expenses directly related to the production of goods by a company.

Cash Flow

Net amount of cash that gets transferred into and out of a company.

Current Ratio

Measures a company's ability to pay its short-term obligations.

d

Debt to Equity Ratio

Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.

Dow Jones

Most-watched and essential stock market indexes in the world and tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.

e

ETF

Asset that tracks a particular set of equities, similar to an index.

EPS

Ratio calculated as a company's profit divided by its number of shares.

f

Fund

Pool of money set aside for a specific purpose.

g

GAAP

Generally Accepted Accounting Principles ("GAAP") are a set of accounting principles, procedures, and standards issued by the Financial Accounting Standards Board (FASB).

h

Hedge Fund

Investment funds that try to beat a specific market benchmark for their investors.

i

Inventory Turnover Ratio

Ratio that shows how many times a business has sold and replaced inventory during a given period.

Index Funds

Fund designed to mimic the composition and performance of a financial market index.

j

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k

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l

Leverage

Borrowing funds to boost returns from an investment.

m

Margin

Money that a trader borrows from a broker to invest, and is calculated as the difference between the total value of an investment and the amount of the loan.

Market Cap

Means how much the stock market believes a company is worth.

n

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o

Option

A stock option is a contract that gives you the right to buy or sell a specific stock at a certain future price and date.

p

Profit

Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.

Private Equity

Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private

P/E Ratio

Number that compares a company's stock price to its earnings per share (EPS).

Put

Contract that gives investors the right to sell a specified amount of a specific security at a certain price within a certain time frame.

q

Quick Ratio

Helps investors figure out a company's capacity to pay its current liabilities without the need to sell its inventory and without additional financing.

r

Retained Earnings

How much net income a company has left over after it pays out dividends.

Recession

Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.

RSI

Momentum indicator

ROI

Metric that investors use to compare different investments.

ROE

Return on equity (ROE) is an indicator calculated by dividing net income by shareholder's equity (company's assets minus its debt)

Leverage

How can I use leverage when trading stocks?

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A

Assets

Accounts Payable

B

C

Cost of Goods Sold

Cash Flow

Current Ratio

d

Debt to Equity Ratio

Dow Jones

e

ETF

EPS

f

Fund

g

GAAP

h

Hedge Fund

i

Inventory Turnover Ratio

Index Funds

j

k

l

Leverage

m

Margin

Market Cap

n

o

Option

p

Profit

Private Equity

P/E Ratio

Put

q

Quick Ratio

r

Retained Earnings

Recession

RSI

ROI

ROE

s

Stimulus Package

Shorting a stock

Stock

S&P 500

Stock Market