Leverage (or financial leverage) is an economic term for the effect, when the investor trades in the financial market not only with his own capital, but especially with the use of additional foreign capital. This multiplies the investment made and the result is the multiplication of profit or loss.
Use of leverage in practice: The basic principle of leverage is the usage of additional foreign capital - for trading with leverage, financial derivatives are often used. IT is then possible to control more valuable assets with little equity. Leverage is used to increase the value of equity and for trading on financial markets, especially with foreign currencies (see Forex). It can also be used to increase the return on equity, when foreign capital is used in the capital structure of the company.
Leverage was one of the fundamental causes of the financial crisis and banking crisis in 2008. It was used to improve business results, together with the use of financial derivatives with worthless underlying assets in trading on the stock exchanges.
Example: Trading with leverage 1:100 means that for own $ 1, a broker will lend $ 100. In the case of profit, the profit multiplies 100 times, in case of loss the broker has to deduct $ 100 previously loaned.