Leverage Risks: The Steep Cliff Behind High Returns

Leverage trading is attractive because it allows you to aim for higher profits with a small capital. However, behind this allure lies the significant risk of substantial losses. Many novice traders focus only on the profit potential of leverage and end up losing their accounts due to losses exceeding expectations. In this article, we will systematically explore the definition of leverage, why leverage trading is risky, and how to manage these risks effectively.

What is leverage and why is it a double-edged sword?

Leverage refers to borrowing funds from a broker to conduct trades larger than your own capital. It’s similar to the principle of a lever, where a small force can move a large object.

For example, suppose you have 1 million won. Investing this amount without leverage yields a profit of 10,000 won if the price rises by 1%. But if you open a position of 10 million won using 10x leverage, a 1% increase results in a 100,000 won profit. The profit is amplified tenfold.

But here’s the critical point. What happens if the price moves in the opposite direction? A 1% decline results in a loss of 10,000 won. You lose 10% of your initial capital at once.

Let’s consider an even more extreme case. If you are trading with 20x leverage on 20 million won and the price drops by just 5%, the loss amounts to exactly 1 million won. You lose your entire initial capital. This illustrates the core risk of leverage.

The vicious cycle of margin and margin calls

When engaging in leverage trading, you must deposit collateral(margin) with the broker. This serves as a guarantee that you can cover potential losses.

A key point here is the margin call. If your account balance falls below the broker’s required margin level, the broker demands additional funds. If you fail to meet this requirement, your position will be forcibly liquidated.

If the market moves unexpectedly and you receive a margin call, you are forced to realize losses and close your position. This mechanism amplifies the risk of leverage.

Leverage trading vs spot trading: what are the differences?

The biggest advantage of leverage trading is capital efficiency. With 1 million won, you can open only one non-leverage position of that size. But with 10x leverage, you can invest in multiple assets simultaneously with the same capital. This makes portfolio diversification easier.

You can also trade high-priced assets that are normally inaccessible.

However, the disadvantages are greater. In non-leverage trading, a 10% price decline results in a 10% loss. But with 10x leverage, the same 10% drop results in a 100% loss, meaning your entire capital is wiped out.

Moreover, leverage trading imposes a significant psychological burden. Small price movements can lead to large gains or losses, often causing emotional trading. This can lead to a vicious cycle of impulsive decisions and increasing losses.

Is leverage trading suitable for you?

Before starting leverage trading, consider the following:

First, are you prepared to handle losses exceeding your capital? Leverage trading can result in losses larger than your initial investment. You need to seriously consider whether you can psychologically accept this.

Second, do you understand the market well? Without knowledge of market structure, technical analysis, and fundamental analysis, leverage can be a poison. Lack of experience is a shortcut to losses.

Third, can you adhere to risk management rules? This is the most important. You must be willing to strictly follow principles like loss limits, position sizing, and portfolio diversification.

Generally, leverage trading is recommended only for experienced traders with deep market understanding, clear trading plans, and strong psychological control. It is especially risky in volatile or illiquid markets.

The pros and cons of leverage trading

Advantages:

• High profit potential: small price increases can generate significant gains
• Capital efficiency: enables various strategies with minimal initial capital
• Access to high-priced assets: assets normally unavailable for purchase can be traded
• Hedging: reduces costs for position protection
• Portfolio diversification: invest in more assets with the same capital

Disadvantages:

• High loss risk: losses are amplified along with gains
• Margin call risk: forced liquidation upon margin deficiency
• Market volatility risk: extremely vulnerable to sudden price swings
• Borrowing costs: interest and swap fees can erode long-term profits
• Emotional stress: psychological burden can lead to mistakes

Practical strategies to manage leverage risks

Vague fears are not enough. Concrete management methods are necessary.

1. Always set a stop-loss
Predefine your stop-loss price when opening a position. This limits losses if the market moves against your expectations. Ignoring stop-losses due to emotions can cause losses to snowball.

2. Do not overexpose your position
Limit losses on a single position to 1-2% of your total capital. For example, if you consider 1 million won as trading capital, restrict your maximum loss per trade to about 10,000 won. This way, multiple losses won’t wipe out your account.

3. Avoid excessive leverage
Extreme leverage like 50x or 100x in volatile markets can lead to ruin. Especially for beginners, start with conservative leverage of 2x–5x.

4. Continuously monitor the market
Don’t set and forget. Regularly check market news, technical signals, and trends, and adjust your positions as needed.

5. Use trailing stops
Gradually raise your stop-loss as profits grow to protect gains and reduce risk.

6. Keep a trading journal
Record reasons for opening trades, outcomes, and lessons learned. Analyzing past trades helps avoid repeating mistakes.

7. Diversify your portfolio
Invest across multiple assets and markets to prevent a single loss from threatening your entire account.

Main trading forms involving leverage

Forex trading: The forex market has relatively small daily fluctuations, leading traders to use high leverage(100x or more). But high leverage means high risk.

Futures trading: Contracts to buy or sell assets at predetermined prices in the future. Small price movements can generate large gains or losses.

Options trading: Buying and selling rights to buy or sell assets at specific prices, representing an extreme form of leverage. Very risky for beginners.

Conclusion: Facing leverage wisely

Leverage is merely a tool. When used correctly, it can be a powerful means of wealth accumulation. But reckless use can quickly deplete your capital.

Understand leverage risks thoroughly before trading. Prioritize loss management over profits. Objectively assess your psychological state, market knowledge, and capital size to decide whether to engage in leverage trading.

For inexperienced beginners, it’s wise to build a foundation with spot trading first. Only when you understand the market and can control your emotions should you consider leverage. There’s no need to rush into leverage.