What is leveraged trading? The secrets behind doubling your principal and instant liquidation

One Sentence Understanding of Leverage Trading

Leverage trading is a method of trading that uses a small amount of margin to control a large position. Simply put, if you have 100,000 yuan, you can borrow 900,000 yuan, using 1 million yuan to trade—that’s 10x leverage. Archimedes said, “Give me a place to stand, and I will move the Earth,” and in financial markets, the power of leverage is equally astonishing.

But this double-edged sword can also hurt the most. If the market moves as you expect, your gains can double; if the market reverses, your principal can vanish in an instant.

Leverage and Margin: Two Easily Confused Concepts

Many people confuse leverage and margin, but they are fundamentally different:

• Leverage: refers to the debt you assume—borrowed money
• Margin: the funds you must pledge—your own money

Taking Taiwan index futures as an example: suppose the recent closing price is 13,000 points, each point worth 200 yuan. The total value of one Taiwan index futures contract is 2,600,000 yuan. But you don’t need to pay the full amount; only 136,000 yuan as margin, and the leverage multiple is:

2,600,000 ÷ 136,000 ≈ 19.11 times

This means controlling assets worth 2.6 million yuan with just 136,000 yuan.

Leverage Returns vs. Risks: A Harsh Contrast

Using the same Taiwan index futures example with a margin of 136,000 yuan:

If the index rises 5%

• From 13,000 to 13,650 points
• Profit = ((13,650 - 13,000)) × 200 = 130,000 yuan
• Return rate up to 96%! Making 130,000 yuan from 136,000 yuan

If the index falls 5%

• From 13,000 to 12,350 points
• Loss = ((13,000 - 12,350)) × 200 = 130,000 yuan
• Almost wiping out the principal, leaving nothing

The same 5% fluctuation amplifies both gains and losses through leverage. The higher the leverage multiple, the more dramatic this effect.

Main Tools for Leveraged Investment

Leverage investment tools allow controlling a larger market value with less capital, mainly including four types:

Futures

Futures are agreements between two parties to buy or sell an underlying asset at a predetermined price at a specific future date. Trading occurs mainly on futures exchanges using standardized contracts.

Common futures include:

• Metal futures (gold, silver, aluminum, etc.)
• Index futures (Dow Jones, S&P 500, NASDAQ, Hang Seng Index, etc.)
• Agricultural futures (wheat, soybeans, cotton, etc.)
• Energy futures (oil, natural gas, crude oil, coal, etc.)

Futures contracts specify the underlying asset, price, and expiration date. Traders can close or roll over positions before expiration, settling at the spot market’s settlement price.

Options

Options give the holder the right (not obligation) to buy or sell an asset at a specified price at a future date. Compared to futures’ mandatory execution, options are more flexible but often come with higher costs (premium).

Leveraged ETFs

These funds use leverage to amplify the index’s gains or losses. For example, a “daily 2x ETF” can double the index’s daily movement.

Note that leveraged ETFs have high trading costs—often 10 to 15 times higher than futures trading costs. They perform poorly in sideways markets and are suitable for short-term trading rather than long-term holding.

Contracts for Difference(CFD)

CFDs allow traders to engage in two-way trading (long or short) conveniently, without owning the actual assets, and without settlement or rollover issues like futures.

CFDs are non-standardized contracts; trading conditions and product specifications vary across platforms. Using margin, you can trade stocks, precious metals, commodities, indices, forex, cryptocurrencies, and other global assets.

For example: one Amazon share costs $113.19. Using 20x leverage, you only need to put up $5.66 to trade one share.

Advantages and Disadvantages of Leveraged Investment

Main Advantages

• Improves capital utilization: Small investors can make large investments, significantly reducing transaction costs
• Magnifies profits: Trading products worth 1,000 or 10,000 dollars with 100 dollars can exponentially increase gains

Main Disadvantages

• Increased risk of liquidation: The higher the leverage, the larger the position relative to your capital, increasing the risk of margin calls
• Amplified losses: Losses are magnified by leverage; a small decline can wipe out your capital

The Real Killer of Leverage: Psychological Traps and Liquidation

Many young investors hold a dangerous mindset: “If I win, I make a fortune; if I get liquidated, I just don’t top up.” But markets are not that gentle.

A real case serves as a warning: Korean YouTuber Satto in 2022 engaged in high-leverage Bitcoin futures trading, using 25x leverage to long BTC at $41,666. When Bitcoin dropped below $40,000, he added more leverage, ultimately losing over $10 million within hours.

This reveals that the most dangerous aspect of leverage trading isn’t the tool itself, but:

• Overconfidence: overestimating your judgment
• Unmanageable leverage: using multiples far beyond your risk capacity
• Lack of discipline: no stop-loss, adding to losing positions

Tips for Risk Control in Leveraged Trading

If you decide to use leverage, these risk management principles are essential:

1. Reduce leverage multiple: add more margin to lower leverage. Better to earn less but survive longer.
2. Set strict stop-losses: your last line of defense. Trading without stop-loss is like driving a car without brakes at high speed.
3. Start with low leverage: practice your trading strategies with 1x or 2x leverage, then gradually increase.
4. Ensure sufficient capital: make sure even if you lose, you won’t be forcibly liquidated.
5. Avoid overtrading: high volatility products with high leverage are suicidal.

Conclusion: Leverage Can Be Used, But Be Smart About It

Robert Kiyosaki mentioned in Rich Dad Poor Dad that moderate leverage is a way to increase returns, but the key is how to properly use borrowed money to build real wealth.

Leverage itself isn’t inherently good or bad; the issue lies in the user’s attitude:

• If you use leverage to amplify high-risk trades, you’re gambling
• If you use leverage under full risk control, you’re improving efficiency

Remember: what is leverage? It’s an amplifier—amplifying your correct decisions and your mistakes. Always start with low leverage and remember to set stop-losses.