Understanding Leverage

Here is an example of using leverage that most people will be familiar with.

Real estate.

Say you bought a house for investment purposes. For simplicity, let’s say it cost $100,000 and you put down 10%, or $10,000.

For simplicity, I am also going to ignore interest payments on the mortgage, realtor commissions and other expenses.

Now, two months later, you sell that house for $105,000, a 5% gain.

Did you make 5%?

No, you made a whole lot more than that. Remember, you only put down $10,000. So a $5000 gain on a $10,000 investment is a 50% profit.

When you put down 10% on the purchase price, you used 10:1 leverage. IE, for every $1 you invested, you “controlled” $10 of the house.

Same thing happens when you are trading forex. You deposit a down payment and control a larger balance depending on which level of leverage you use.

The leverage can also result in larger losses than unleveraged investments, too.

If that house had declined $5000 in value instead of rising, you would LOSE 50% of your investment when you sold for $95,000.

At 10:1 leverage, you are gaining or losing 10% of your initial investment for every $1000 in the fluctuation of the market value of that house.

At 50:1 margin (a 2% downpayment), you are gaining or losing 50 times every $1 of your investment with each change. A $5000 increase (or decrease) at that leverage would be 250% of your $2000 downpayment on the house.

This is why leverage can so significantly make or break your fortune!!!