Leverage allows traders to control larger positions in the market with a smaller amount of capital. While it increases the potential for profit, it also significantly amplifies risks. If the market moves against your position, your losses can quickly exceed your initial investment. One key consequence of improper leverage use is the risk of receiving a margin call.

Leverage Risks

1. Amplified Losses: While leverage enhances potential profits, it also magnifies losses. For example, with 10:1 leverage, a 1% move against your position results in a 10% loss relative to your capital. If the market moves sharply, losses can escalate quickly, potentially wiping out your account.
2. Overexposure: Leverage can tempt traders to take on larger positions than they can afford, leading to overexposure to market risk. Large leveraged positions make your account more vulnerable to sudden market movements and volatility.
3. Market Volatility: High volatility increases the risk of leveraged positions being wiped out due to sharp price fluctuations. When markets move fast, positions that seemed manageable can turn into substantial losses in minutes or even seconds.

What is a Margin Call?

A margin call occurs when the value of your account falls below the broker’s required margin level due to losses. Essentially, the broker requires you to either:

• Deposit more funds to maintain your position.
• Close or reduce your position to meet the required margin.

How Margin Calls Work

1. Initial Margin: When you open a leveraged position, you need to maintain an initial margin (a minimum amount set by the broker) in your account. If your account equity drops due to market movements, your margin level decreases.
2. Margin Call Level: If your account equity falls below the required maintenance margin (e.g., 50% of the total position value), the broker issues a margin call.
3. Forced Liquidation: If you fail to meet the margin call by depositing more funds, the broker may liquidate your position to prevent further losses, often resulting in a realized loss.

Conclusion

Leverage amplifies both profits and risks. Improper use of leverage can lead to margin calls or even account liquidation. To avoid this, traders must use leverage cautiously, apply proper risk management, and monitor positions closely to prevent significant losses.