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.
Leverage, in stock trading, is the use of borrowed money to take a position larger than the trader's cash would normally allow. The trader puts down a fraction of the position value as a deposit, and the broker lends the rest. The position behaves as if the trader owned the full amount, and the gain or loss is calculated on the full position size. The cash the trader put down is the only money at risk, but the return (positive or negative) is amplified by the leverage ratio.
The basic example
A trader has €10,000 in a brokerage account and wants to buy €30,000 of a stock. The trader puts up €10,000 of their own cash and borrows €20,000 from the broker. The position is a €30,000 long position, and the trader's cash is the equity in the position. The leverage ratio is 3:1, meaning the position is three times the trader's cash.
If the stock rises 10%, the position is worth €33,000, and the trader owes the broker €20,000 plus any financing. The trader's equity is €13,000 minus the financing, which is a 30% return on the original €10,000. If the stock falls 10%, the position is worth €27,000, and the trader's equity is €7,000 minus the financing, which is a 30% loss.
The 3:1 leverage amplifies the 10% move into a 30% move on the trader's cash. The amplification works in both directions, and the trader who is right about the direction of the stock makes a larger return than an unleveraged position would have produced. The trader who is wrong about the direction loses a larger amount.
How the broker lends the money
The broker lends the money against the trader's cash and the position itself. The cash and the position are the collateral for the loan, and the broker has a secured interest in both. If the position moves against the trader, the equity in the account falls, and the broker's secured interest becomes a larger portion of the account. If the equity falls below a defined threshold (the maintenance margin), the broker issues a margin call.
The margin call is the broker's way of saying that the trader's equity is no longer enough to support the loan. The trader is asked to deposit more cash, close part of the position, or both. If the trader does not respond, the broker closes the position at the worst available price, locks in the loss, and charges a fee.
The cost of the loan
The loan is not free. The trader pays a financing rate on the borrowed portion, and the rate is published on the broker's product page. The rate is usually 2% to 4% above the broker's cash rate, and it accrues daily. The cost is paid whether the position gains or loses, and it is a real drag on the return.
The cost of the loan is the most common reason that leveraged positions underperform unleveraged positions over long horizons. A trader who holds a 3:1 leveraged position for a year and produces a 10% gross return on the underlying produces a return of 30% × the leverage factor minus the financing cost. The financing cost is 2% to 4% on the borrowed portion, which is 4% to 8% on the trader's cash. The cost compounds, and it is paid whether the trade wins or loses.
The leverage ratio
The leverage ratio is the position size divided by the trader's cash. A 2:1 leverage ratio means the position is twice the trader's cash, and a 5:1 leverage ratio means the position is five times the trader's cash. The leverage ratio is the multiplier on the trader's return, and it is the most important parameter in the trade.
The leverage ratio is set by the broker and the regulator. The broker sets the maximum leverage available for the instrument, and the regulator sets the maximum leverage available for retail traders in the trader's jurisdiction. ESMA in the EU caps retail leverage at 1:5 for major stocks, which is a 5:1 leverage ratio or a 20% initial margin. The FCA in the UK has similar caps. Offshore brokers can offer higher leverage, but the regulatory protection is thinner.
The margin call
The margin call is the broker's mechanism for managing the loan. The call fires at the maintenance margin, which is usually lower than the initial margin. For a major US stock with a 50% initial margin and a 25% maintenance margin, the position is opened with a €5,000 deposit on a €10,000 position, and the margin call fires when the trader's equity falls to 25% of the position value, which is €2,500.
The margin call is a real event with real consequences. The trader who does not respond to the call is forced to close the position at the worst available price, and the loss is locked in. The trader who responds to the call by depositing more cash is doubling down on a losing position, and the doubling down is rarely the right move.
The honest use of leverage
Leverage is a tool for short-term tactical positions, for hedging, and for capital efficiency. The trader who uses leverage for a long-term hold is paying the financing cost for the entire hold period, and the cost is a real drag on the return. The trader who uses leverage for an unhedged directional bet is exposed to the full drawdown on the position, and the drawdown can be larger than the trader's risk budget.
The honest rule is to size the position to the stop and the account, and to use whatever leverage is required to produce the correct dollar risk. The leverage figure is the result of the position sizing, not the input. The trader who can do this consistently is using leverage correctly. The trader who cannot is using leverage as a default, and the default is rarely the right answer.
Related resources
Where to start
If you are evaluating leverage for your strategy, the most useful exercise is to calculate the dollar risk at the stop, and to use the leverage required to produce that risk on a small position. Our broker comparison lists the leverage available at each broker and the regulator that supervises the account, which together tell you what is on the table before you open the position.