Glossary
Leverage
Using borrowed money or derivatives to increase the size of a position, magnifying both gains and losses.
Leverage means controlling an exposure larger than the money you have put in, by borrowing or by using instruments such as options and futures. It works in both directions: the same multiple that enlarges a gain enlarges a loss, and losses can exceed the original stake. In company analysis the word also describes how much debt a business carries relative to its equity.
How leverage magnifies returns
Kinds of leverage
- Account leverage: margin loans from a broker, where US rules let most stocks be bought with 50% initial margin.
- Embedded leverage: options, futures and leveraged ETFs, which give large exposure for a small outlay.
- Financial leverage in a company: debt in the capital structure, measured with ratios such as debt-to-equity or debt to EBITDA. It raises return on equity in good years and the risk of distress in bad ones.
- Operating leverage: a high share of fixed costs, so profit swings more than sales.
What to watch for
Leverage shrinks the distance to forced selling. With borrowed money, a fall in price can trigger a margin call, and a broker may liquidate holdings at the worst moment. Position size, not just the choice of investment, decides how much a leveraged loss can hurt.