Leverage

What Is Leverage?

Leverage means using borrowed capital or instruments with embedded borrowing to control a larger position than your own cash would allow. If an investment rises, the gain is measured against your own money, so the percentage return looks bigger. If it falls, the loss is magnified in the same way, and you still owe the borrowed amount.

How Leverage Works

Investors most often use leverage in a few common ways:

• Margin borrowing, where a brokerage lends money against securities held in a margin account
• Derivatives such as options and futures, which give exposure to a large notional value for a smaller upfront payment
• Leveraged funds, which use borrowing or derivatives internally to target a multiple of an index's daily move
• Borrowing to buy an asset, such as a mortgage on a property

The key measure is the ratio of total position value to the investor's own equity. A position of 10,000 dollars funded with 5,000 dollars of your own money and 5,000 dollars borrowed is two times leveraged. A 10 percent gain on the full position becomes a 20 percent gain on your equity, while a 10 percent drop becomes a 20 percent loss, before interest and fees.

Why It Matters to Investors

Leverage cuts both ways. Losses can exceed the original investment in some strategies, such as short selling or uncovered options, and a falling position can trigger a margin call requiring additional cash or forced sales at unfavorable prices. Borrowing costs also reduce returns, and leveraged products that reset daily can drift from their stated multiple over longer periods.

Understanding leverage helps investors see the true risk of a position, not just its potential reward. Reviewing how much of a portfolio is financed by debt, and how much a moderate price move would change equity, is a common way to assess that risk.