Investment Leverage Analysis: From 5x to 20x, The Art of Balancing Risk and Reward

Leverage in investing is one of the most attractive yet dangerous tools in the financial markets. Many traders are drawn to its promise of amplified returns but often overlook the lurking risk of liquidation. This article will delve into the essence of leverage, its operational mechanisms, available tools, and risk management strategies.

What are the core tools of investment leverage?

Investment leverage is not a single tool but a collective term for trading methods. There are four main types of instruments that allow investors to control a larger market value with relatively small capital:

Futures Trading

Futures are standardized contracts where both parties agree to buy or sell an asset at a predetermined price at a specific future date. Trading occurs mainly on futures exchanges. Common futures include metals (gold, silver, aluminum), indices (Dow Jones, S&P 500, Hang Seng Index), agricultural products (wheat, soybeans, cotton), and energy (crude oil, natural gas, coal). Futures contracts specify the underlying asset, price, and expiration date. Traders can choose to close or roll over their positions before expiry.

Options Trading

Options give the holder the right, but not the obligation, to buy or sell the underlying asset at an agreed price within a certain timeframe. Unlike futures, which are forced settlements, options offer more flexible risk management but have more complex pricing mechanisms.

Leveraged Exchange-Traded Funds (ETFs)

Common products include “leveraged ETFs” and “double leveraged ETFs.” These funds are suitable for short-term active investors but have trading costs 10–15 times higher than futures and tend to perform poorly in consolidating or choppy markets.

Contracts for Difference (CFD)

CFDs allow traders to conduct two-way trading conveniently without holding the actual assets or engaging in complex margin procedures, nor dealing with rollover issues typical of futures. Traders can use margin to trade a variety of global assets, including stocks, precious metals, commodities, forex, and cryptocurrencies.

How does investment leverage work?

The relationship between leverage and margin

Many confuse the concepts of leverage and margin. Leverage actually refers to borrowing, while margin is the collateral required to open a position. Although related, they are fundamentally different.

For example, using Taiwan index futures:

Suppose the recent closing price is 13,000 points, with each point worth 200 NT dollars. The total value of one Taiwan index futures contract is: 13,000 points × 200 NT$/point = 2,600,000 NT$

If the futures exchange requires a margin of 136,000 NT$, the leverage multiple is: 2,600,000 NT$ ÷ 136,000 NT$ ≈ 19.11 times

This means with 136,000 NT$, you can control assets worth 2.6 million NT$.

Real-world profit and loss with leverage

Assuming the Taiwan index rises by 5% (from 13,000 to 13,650 points): Profit = (13,650 - 13,000) × 200 NT$/point = 130,000 NT$

With a principal of 136,000 NT$, the return rate is 96%.

Conversely, if the index drops by 5% (to 12,350 points): Loss = (13,000 - 12,350) × 200 NT$/point = 130,000 NT$

The principal is nearly wiped out.

This case clearly illustrates a key principle: the higher the leverage multiple, the greater the potential gains and losses are magnified by the same factor.

Advantages and risks of investment leverage

The appeal of leveraged investing

The main advantage of using leverage is significantly improving capital efficiency. Small investors can engage in high-value trades with less capital, saving costs. Moreover, if market predictions are correct, profits can multiply—trading products worth 1,000 or even 10,000 USD with just 100 USD can lead to proportional profit increases.

Hidden dangers of leveraged investing

The biggest risk is “liquidation.” If the market moves against the position, losses are also amplified. If investors cannot quickly add funds, brokers will forcibly close positions to avoid risk, resulting in total loss of the account. The larger the leverage, the higher the probability of liquidation under the same market volatility.

Real warning case

In 2022, Korean YouTuber Satto experienced liquidation during a live crypto futures trading session. He opened a 25x leveraged long position when Bitcoin was at $41,666. After Bitcoin fell below $40,000, he added more leverage longs, losing over $10 million within hours. This case vividly demonstrates how uncontrollable leverage and immature trading strategies can lead to fatal errors.

Practical advice for leveraged trading

Start with low leverage

Regardless of the product traded, investors should begin practicing with low leverage ratios, gradually adapting to market volatility. This process helps accumulate trading experience and develop risk awareness.

Set stop-loss orders

Stop-loss is the last line of defense to protect the account. Always pre-set stop-loss levels before opening a position and strictly adhere to them, avoiding changes due to short-term market fluctuations.

Be prepared for volatility

Investors must be ready for possible sharp market swings by maintaining sufficient capital reserves. Do not allocate all funds to a single trade; keep a risk buffer.

Cautiously evaluate leverage multiples

It is recommended to allocate more margin and reduce leverage ratios. Lowering leverage is not a sign of passivity but a rational risk management decision.

The dual nature of investment leverage

Legendary investor Robert Kiyosaki once pointed out that moderate use of leverage is an effective way to increase returns. The key is not whether to use leverage but how to properly utilize borrowed funds to grow wealth.

Leverage itself is not a monster. If investors can control risks and apply leverage to enhance returns, it can be a powerful asset growth tool. However, if used on highly volatile products without proper risk management, leverage can quickly turn into a trap of total loss.

Before engaging in leveraged trading, remember: start with low leverage and always set a stop-loss. These two principles may seem simple but are invaluable lessons learned through countless traders’ blood and tears.