Leverage In Stock Markets is a way in which an Individual uses money from the broker to take positions in the Stock Market. Using leverage is increasing your Purchasing power from a loan provided by the broker for some nominal charge. Leverage on Intraday trades are provided for free but for traders that are taken for delivery, the broker charges some interest on the funds loaned to the Individual. Taking trades with Leverage can wipe out a trader’s capital if not done with proper Risk management, hence leverage should be used as little as possible.
Leverage In Stock Market-
Leverage in Stock Market means borrowing money from the broker to take positions in the Secondary Market. Leverage can range from broker to broker and also depends on the types of orders.
Using leverage to trade is like ‘Using a 2 sided Sword’ If went right then the trader can get handsome rewards, on the other hand, if the trade goes wrong, then the whole capital can get wiped off in one single trade.
Leverage are of 2 types-
- Intraday Leverage
- Delivery Leverage
1.Intraday leverage-
Intraday leverage is provided by stockbrokers to its customers for taking positions that are worth more than the cash balance of the individual’s trading account. The intraday trades are closed within the same day. Intraday leverage is the highest leverage provided by the broker to its customers as the probability of a substantial loss is less as the positions are squared off in a single trading day. Even within Intraday Leverage, there are categories where a trader can take less or more Leverage for any positions. There are many types of intraday orders such as
- MIS (Margin Intraday Square off)
- CO (Cover Order),
- BO (Bracket order)
In a MIS order, the margin is comparatively less than that of CO or BO as the overall risk is more. Whereas in CO & BO the leverage provided is the highest as the total risk in such orders is limited by a mandatory Stop-loss order (SL) that will square off the trade if the price reaches the pre-set Stop loss. There are no extra charges for using leverage by the broker, but as the turnover is higher, the brokerage and other Taxed generated will be high.
2.Delivery Leverage-
The second type of leverage provided by the brokers is Delivery leverage where an individual can borrow money from the broker to hold on to the position for more than ‘1’ day. Delivery leverages are riskier as the overall loss probability increases as the position is carried forward for more than 1 day.
Hence there is a charge on delivery Margin by brokers as Interest, that ranges from ‘0.25%-1%’ of the leveraged amount per day. This interest is pretty high as the trader is indirectly borrowing money from the broker to buy Stocks in his name.
As the Stock Markets have gathered popularity in recent times, many Small Retail traders with small capital are drawn towards Leverage thinking Leverage is a way to get Rich quick whereas the opposite happens while trading with leverage as One doesn’t realize the risk involved and end up losing their entire savings trying to main Huge profits.
For example,-
if one has Rs1000 in their trading account then without leverage, one can only buy 10 shares of Rs100, but if the broker provides 10-time leverage then with the same 1000, in their account one can buy 100 shares of the same Script. In this way, their ROI (Return On Investment) can increase largely if the trade goes in their favor,
If the stock moves 5% then without leverage, the return on capital would be just 5% but with leverage, the return of capital can be an astonishing 50%.
On the contrary, if the stock goes down by 5% then without leverage, the loss of capital would be a mere 5% but with leverage, the loss faced would be 50% of the capital. Therefore by now, it should be clear how using Leverage can be bad.
To protect the capital of small Retail Traders, NSE has taken some measures and restricted the total leverage limit allowed by the brokers to 50% in March 2021 and expects to reduce the leverage to 0% in Intraday by the end of this calendar year(2021).