This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
Leveraged products are not suitable for all investors, and the suitability depends on the investor's experience, the investor's risk tolerance, and the investor's financial situation. The leverage that produces a 5 percent gain on a 5:1 position can produce a 5 percent loss, and the loss can be larger than the gain because of the spread, the commission, and the financing charge. The investor should understand the suitability criteria before opening a leveraged position, and the investor should look at the alternatives if the criteria are not met.
Who should consider leveraged products
The first group is experienced traders. The trader who has placed hundreds of trades, who understands the leverage mechanics, and who has a consistent track record can consider leveraged products. The experience is necessary because the leveraged products require quick decisions, and the leveraged products require a solid understanding of the margin and the risk management.
The second group is high-risk-tolerance investors. The investor who can stomach a 20 percent loss on a single position without panic, and the investor who has a long time horizon, can consider leveraged products. The high risk tolerance is necessary because the leveraged products can produce large losses, and the leveraged products can produce large losses in a short period.
The third group is investors with a diversified portfolio. The investor who has a diversified portfolio, and the investor who can afford to lose the leveraged position without affecting the financial goals, can consider leveraged products. The diversification is necessary because the leveraged products add risk to the portfolio, and the leveraged products should not be a large portion of the portfolio.
Who should avoid leveraged products
The first group is beginners. The beginner who is still learning the basics of trading, and the beginner who has not yet developed a consistent track record, should avoid leveraged products. The beginner should start with unleveraged products, and the beginner can move to leveraged products once the beginner has the experience.
The second group is low-risk-tolerance investors. The investor who cannot stomach a 10 percent loss, and the investor who needs the money for a specific goal in the short term, should avoid leveraged products. The low risk tolerance is incompatible with the leveraged products, and the low risk tolerance can lead to panic selling at the wrong time.
The third group is investors with a concentrated portfolio. The investor who has a large portion of the wealth in a single stock or sector, and the investor who cannot afford to lose the leveraged position, should avoid leveraged products. The concentration adds risk, and the concentration combined with the leverage can be catastrophic.
The fourth group is investors close to retirement. The leveraged products are too risky for a portfolio that needs to generate income.
The suitability assessment
The first criterion is the experience. The investor should have at least one to two years of trading experience, and the investor should have a consistent track record. The experience is a prerequisite, and the experience is the foundation of the risk management.
The second criterion is the risk tolerance. The investor should be able to stomach a 20 percent to 30 percent loss on a single position, and the investor should not panic during a downturn. The risk tolerance is a personal characteristic, and the risk tolerance can be assessed through a questionnaire.
The third criterion is the financial situation. The investor should have a diversified portfolio, and the investor should have a cash buffer to cover the margin calls. The financial situation is the foundation of the risk management, and the financial situation should be stable before the investor considers leveraged products.
The fourth criterion is the time horizon. The investor should have a long time horizon, and the investor should not need the money for a specific goal in the short term. The time horizon allows the investor to ride out the downturns, and the time horizon reduces the pressure to sell at the wrong time.
The main risks for unsuitable investors
The first risk is the loss amplification. The investor who does not understand the leverage can lose more than the initial deposit, and the investor can lose the entire deposit on a single trade. The loss amplification is the main risk of leveraged products, and the loss amplification is amplified by the spread, the commission, and the financing charge.
The second risk is the margin call. The investor who does not have a cash buffer can be forced to liquidate the position at the worst possible time. The margin call can happen at any time.
The third risk is the psychological pressure. The investor who cannot handle the pressure can make emotional decisions, and the investor can sell at the wrong time.
The alternatives for cautious investors
The first alternative is the unleveraged stock purchase. The investor who wants to participate in the stock market can buy the stocks directly, and the investor can build a diversified portfolio over time. The unleveraged purchase is the safest way to invest, and the unleveraged purchase is suitable for all investors.
The second alternative is the ETF. The investor who wants diversification can buy an ETF, and the ETF can be a broad market ETF or a sector ETF. The ETF is a low-cost way to invest, and the ETF is suitable for investors with a small account.
The third alternative is the mutual fund. The investor who wants professional management can invest in a mutual fund. The mutual fund is suitable for investors who want a hands-off approach.
Common questions about leveraged product suitability
What is the minimum experience for leveraged products? The minimum experience is one to two years of consistent trading, and the minimum experience includes a track record of profitable trades. The beginner should not use leveraged products.
Can I use leveraged products with a small account? Yes, but the small account is more vulnerable to a margin call, and the small account can be wiped out by a single trade. The trader with a small account should use a lower leverage, and the trader should keep a cash buffer.
What is the maximum leverage for retail clients? In the European Union, the maximum leverage for retail clients is 1:30 on major forex pairs and 1:5 on stocks. The maximum leverage is set by the regulator, and the maximum leverage is designed to protect the retail trader.
Related resources
Where to start
If you are evaluating leveraged products, the most useful first step is to assess the experience, the risk tolerance, the financial situation, and the time horizon. Our broker comparison lists the brokers that offer leveraged products and the available leverage, which together tell you what the broker offers before you place the first leveraged trade.