Using Leverage to Invest
Many investors and traders use their cash balances to buy and sell their favorite stocks however, there’s a limit to how many shares an investor can acquire because they are restricted by the cash they currently hold. Utilizing leverage in a trading strategy opens a whole new way to invest. It acts by trading on credit with initial amounts upfront and borrowing the rest.
Leverage is related to margin, but what is that?
Using Margin to Trade
Typically when you buy a stock, you need cash to open up a position. Margin trading is essentially borrowing money. A brokerage service may offer a low rate for lending money, bringing much larger buying power to a portfolio.
The account and the assets act as collateral for the brokerage in the event of a catastrophe. This is the responsibility an individual carries because if you default on the borrowed money, the brokerage service still needs their money even if it means selling other assets.
Occasionally, you may be required to add cash to your account. This is a margin call, if you don’t meet the requirements the brokerage has the ability to sell assets in your account to cover it as well.
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Margin trading is one of the riskiest forms of investing if you aren’t aware of the inherent consequences. The individual lending the capital for acquiring stocks entails all of the risks and is responsible for all outcomes while using leverage.
Regardless of the outcome, the individual is solely responsible for the gains, losses, and payback of the loan while using any form of leverage.
Investing in Leveraged ETFs
Instead of taking on the risk of borrowing money within your portfolio, ETFs and funds already have these qualities within their pocket.
An example of a leveraged asset is the ProShares UltraPro QQQ (NASDAQ: TQQQ) ETF that attempts to get a return that is 3x the return of its underlying benchmark Nasdaq 100 Index. Some of the top holdings include Apple, Microsoft, Amazon, Facebook, Alphabet, and Tesla. All very great companies within an ETF that moves at a 3X multiple. Volatility is much more of a concern within this ETF because of the added risk leverage provides.
The benchmark that ProShares UltraPro QQQ ETF uses, the Nasdaq 100 Index, is essentially 100 of the largest companies listed on the Nasdaq Stock Market. These companies are in a wide variety of industries including computer software and hardware, biotechnology, digital payments, and clean energy.
If the Nasdaq 100 moves by 1%, ProShares UltraPro QQQ ETF will theoretically rise by 3%. This also applies to the downside. Every movement is multiplied by 3X which can be a cause for celebration or regret depending on the outcome. Every investor needs to be wary.
ProShares doesn’t just offer this ETF, they also have a wide range of financial assets. Over time, ProShares has also accumulated over $58 billion in assets. The company is a leader in dividend growth, leveraged, and inverse trading ETFs.
The Main Point
Leverage in trading can be beneficial in a portfolio, but also detrimental depending on the risk at hand. It’s very easy to gain exposure to leverage trading, but it does require much more responsibility. There is the risk of having to sell some assets to cover the leveraged position if you decided to borrow money for an investment opportunity.
ProShares UltraPro QQQ ETF can produce large short-term potential, but also large losses. This ETF is only appropriate for investors with a high-risk tolerance with short-term investment periods.
Regardless of the investment, it should be treated with caution and it’s never certain what will happen in the stock market over the short term.
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