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lindagray

Leverage and Short-Trading

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One of the most significant and important innovations that online trading brought is the possibility to trade using leverage and short-trading. Before, traders could only make deals for the sum which they actually possessed and which they deposited into the broker’s account. 

Now, private traders can conclude deals worth 100 times more than the capital they own.

One may ask, how is this even possible? This answer is “leverage” – the broker presents additional capital. To have a better understanding take a look at the following scheme:

A trader wants to purchase 100.000 euros for dollars, but only possesses $1000.

A broker provides the trader with the sum necessary for the deal. At the rate of EUR/USD 1.2000, he will require $120.000. 

The broker makes a deal on behalf of the trader. $1000 in his account becomes a pledge.

If the EUR/USD rate increases, the trader gets the profit. He can close the deal when the rate reaches, for example, 1.2100. In this case, the trader will receive $121.000. $120.000 goes back to the broker, plus the fee that he takes for concluding the deal and providing the leverage. Overall profit for the trader will be $1000 minus the costs. By doing this, the trader can double the sum in his account.

If the EUR/USD rate decreases, the trader loses money. His losses are limited by his security deposit. In case the rate drops to 1.1900, the amount of working capital will decrease from $120.000 to $119.000. If this happens, the broker will have to forcibly close the deal to avoid further losses. The broker will take the remaining $119.000 plus $1000 which belongs to the trader to compensate for the loss. In this scenario, the trader can lose his entire deposit.

Thanks to the leverage, it is now also possible to use the short-trading scheme. A trader can not only buy assets worth much more than his deposit but also sell the assets he does not possess. For example, with only $1000 in his pocket, a trader can open a deal to sell euros (which he does not have) for dollars. In this case, the trader has to take leverage, though not in USD, but in EUR. The remaining part of the deal is similar.

Types of assets you can trade online
There are several types of assets that you can use in online trading. Some of them are categorized as “classic”, and they have been sold for hundreds of years now. Others appeared after the spread of Internet trading. Let’s take a closer look at each category of assets.

Stocks
Stock market shares are one of the oldest types of assets. A stock share is a specific share of a big company that is traded publicly. There are two possible roles for you when making deals in the stock market: the speculator and the investor.

A speculator makes short-term deals. His main goal is to buy low and sell high (or vice versa, to sell for a high price, then buy low). He does not care about any other peculiarity, the only thing that is important is the difference between the purchase price and the sale price.

An investor does not just buy shares to sell them at a higher price. He invests money into the business that has issued the stock. A long-term investment is the highest priority for him. The main source of income for an investor is a dividend. However, the increase in the stock rate also makes his portfolio more valuable, which is also very important.

Cryptocurrencies
Cryptocurrency is the newest asset in contemporary financial markets. But what is it? Let’s dig deeper.

Cryptocurrency is a digital asset created by a complex program code. Bitcoin was the first and the most popular cryptocurrency, and many more were created from this basis. Today, there are more than 2000 different cryptocurrencies and the number is still growing.

Cryptocurrencies are different according to their structure, ideology, and the values they have. Some of them are just a new way of completing financial transactions and are more reliable, fast, and confidential than bank transactions (though there are certainly some cons in this approach). But some cryptocurrencies, or crypto assets, represent platforms for making different applications with advanced functionality or a wide variety of other interesting projects.

As cryptocurrencies are assets, their price is dynamically changing, which means that they can also be traded and bring profits. Just like with shares, you can speculate about cryptocurrency or invest in it (because almost every cryptocurrency has a value).

The main difference between shares and CC is very high volatility:

The rate of an average share may rise by 20-30% in a year, and this will be considered a very good result.

Cryptocurrency may rise by 200-300% in a month, then fall drastically to 20-30% in a day, and this will be considered a normal trend.

libertex.org

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