What does leverage mean, and why is it dangerous?Start here

Controlling more than you paid for. It multiplies the gain, the loss and the speed — and the speed is what actually ruins people.

Leverage means the money at risk is bigger than the money you put up. That is the whole definition. Borrow to buy, or use a product with borrowing built in, and every percentage move on the position lands on a smaller pot of your own money.

How does the arithmetic work?

Put up 100 and control 300. The asset rises 10%, so the position gains 30, and on your 100 that is a 30% gain. Three times the move, exactly as advertised.

Now it falls 10%. The position loses 30 and your 100 is worth 70. A 30% loss. The multiplier does not know which way it is pointing.

Keep going. A 33% fall in the asset wipes out the whole of your 100, while somebody unleveraged is down a third and still holding. The asset did not do anything unusual. The leverage decided what it meant.

What is the cost that comes before any return?

Borrowed money charges interest, and you pay it whether or not the asset moves. With 3× leverage you are borrowing twice your own money, so at 5% interest you are paying 10% of your own stake every year before you are even level.

That is why leverage on a low-returning asset is usually a bad trade even when the direction is right: the asset has to beat the financing cost first, and only what is left over is yours. The leverage page has the break-even calculator.

Why is being closed out worse than being wrong?

This is the part that does the real damage. A leveraged position is watched. If your stake shrinks past a threshold, you get a margin call — put up more money now — and if you do not, the position is sold. Not at a price you chose; at whatever is available.

So being right eventually is not enough. You have to still be in the position when it happens. Markets that fall hard and come back have destroyed enormous numbers of leveraged investors who had the view exactly right and were sold out at the bottom of it. Margin and collateral is about that mechanism.

What does the path do to a leveraged product?

Something people rarely expect. A product that gives you a multiple of the daily move resets every night, and over time the daily steps multiply together rather than adding up.

Take a market that rises 10% and then falls 10%. It ends at 99 — down a touch. A 3× daily product goes up 30%, then down 30%, and ends at 91. Nine percent gone, from a market that barely moved. Repeat it a few times and the gap widens. This is why the factor certificate is built for days rather than months.

Where is leverage hiding when I did not borrow anything?

In more places than most portfolios realise:

• An option, a warrant or a turbo — the gearing is inside the payoff.
• A future or a CFD — you control a large notional on a small deposit.
• Shares in a company that is itself heavily indebted — banks, property companies, utilities. Their leverage is now yours too.
• A mortgage. The most leveraged position most households will ever hold, and rarely thought of that way.

What is the sensible summary?

Leverage does not improve an investment. It concentrates it, adds a running cost, and adds a way to lose that has nothing to do with being wrong. It has real uses — hedging, and financing things whose income covers the interest. Neither of those is "I am confident, so I will use more".