Leverage

Leverage means controlling an exposure larger than the money you have committed. It can come from borrowing, as in a margin account or a mortgage, or be built into products such as CFDs, futures and options, where a small deposit or premium gives exposure to a much larger underlying value. It is often expressed as a ratio: leverage of 5:1 means each 1 of your own money controls 5 of exposure, so a 1% move in the underlying asset produces a 5% change in your capital. Companies can be leveraged too, when they fund themselves with debt; British usage often calls this gearing.

Leverage magnifies returns in both directions, so it can turn a modest fall into a devastating loss. With enough leverage, a small adverse move can wipe out your entire stake, and with many products losses can exceed the money put in, leaving you in debt to your broker. Leverage also adds borrowing costs and the risk of forced selling through margin calls, which can lock in losses even if prices later recover. UK and EU rules cap the leverage retail clients can use on CFDs, but even capped leverage is high risk. For a company, high gearing raises the risk of financial distress when profits fall.