Guide to Leverage Trading in South Africa

Guide to Leverage Trading in South Africa

What is Leverage Trading?

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Top 5 Reasons Why Leverage is Used in Stocks Trading

Leverage is defined as the ability to open a substantially larger position than the value of your capital. You do this by borrowing capital from your broker. When using leverage, you can ‘expand’ the trading power of your ZAR with much bigger positions. Leveraged trades are inherently risky because there is no certainty how they will end. If a trade moves in your favour, leverage multiplies your gains.

But, it’s also possible for leverage to multiply your losses. Fortunately, credible trading brokerages such as AvaTrade South Africa prevent you from losing more than you have deposited. This is guaranteed by way of negative balance protection. South African traders have access to a wide range of financial instruments at AvaTrade, including: FX options, cryptocurrencies, indices, ETFs (Exchange Traded Funds), commodities, and CFD equities.

Traditional trading paradigms focus on buying the underlying financial instrument, waiting for the price to appreciate, and selling it. Of course, it’s entirely possible to short sell financial instruments by hedging against the price. AvaTrade SA offers derivatives trading leveraged products (CFDs) where you simply buy/sell contracts based on price movements.

Leverage can only be offered in amounts permitted by the law, under the purview of the FSCA in South Africa. It requires traders to make a deposit. This deposit is the margin requirement. In an unleveraged position, traders would deposit precisely the amount that they’re able to trade and receive an equivalent trading value of financial instruments. R10,000 in capital offers exposure to R10,000 in financial instruments with unleveraged positions.

However, in a leveraged position you may be able to deposit R100 with R10,000 exposure. The capital/exposure ratio indicates your margin percentage. In this case it is R100/R10,000, or 1% margin. Naturally, the smaller your margin requirement, the bigger the leverage provided by the brokerage. In this case, it is 100:1 leverage. As a rule, it’s best to limit leverage to what is affordable. Leveraged positions are available across multiple different financial instruments, such as stocks, currency pairs, and indices.

 

Here are the top 5 reasons why leverage is used:

 

  • Gearing Opportunities for Stocks Trading 

When you commit a small amount of your capital reserves to CFD stocks trading with leverage, you are essentially freeing up valuable capital for investments elsewhere. This is what is known as gearing.

  • Short Selling Stocks

Many stocks traders in South Africa recognise that we are living through volatile times, what with the pandemic wreaking havoc on financial markets. Amplified short selling activity took place in 2020, and 2021, as the coronavirus resulted in massive layoffs, shuttering of scores of SMEs, and global demand and supply declines. In the face of such overwhelming negative sentiment, speculators typically use leverage to short stocks and benefit accordingly. 

  • Possibility of Enhanced Returns on Investment (ROI)

When trades finish in the money, leveraged positions can certainly be beneficial to you. Plus, you only invest a small percentage of the trade value to derive maximum yield. The flipside of the coin also holds true: margin calls may be required to sell the underlying financial instrument to recoup the losses that result. You may also be required to make an additional deposit to keep a position open.

  • Leveraged Trades Can Be Made 24/7 in Certain Markets

While stock markets typically trade from 9:30 AM to 4:30 PM Monday through Friday USA EST, other markets such as cryptocurrency, currency pairs trading, and certain indices are available around-the-clock. This makes leveraged trading particularly exciting to South Africans.

  • Leveraged Stocks Trading Comes with Hedging Tools

When you trade stocks using leverage, there are protections available to you in the form of negative balance protection, guaranteed stops to protect against slippage or gapping, and stop loss orders.

Benefits of Trading Stocks as CFDs in South Africa

The South African economy ranks among the most prosperous African markets, alongside Nigeria, and Egypt. While the Nigerian economy is far and away the biggest in terms of GDP (Gross Domestic Product) with an estimated $446.543 billion in 2020, South Africa follows with a GDP of $358.839 billion. Egypt is close in tow with a GDP of $302.256 billion. The SA economy, ranked 35th by global standards has a GDP per capita of $6,100 (2019), and is categorised as an upper middle income country, and a developing nation. South Africa’s developed infrastructure, particularly its banking and financial institutions are on par with the best of the west. Trading activity in South Africa is equally robust. The JSE (Johannesburg Stock Exchange) boasts some pretty impressive statistics vis-a-vis stocks trading. As a case in point, the JSE Markets Weekly Statistics for the week ending March 5, 2021 reflected the following figures:

  • Number of trades – 1,718,188, with an 18.24% change year on year through March 2021.
  • Volume of trades (000’s) – 3,370,864 with an 80.84% change year on year through March 2021.
  • Value in ZAR (000’S) – 108,438,769 with a 27.05% change year on year through March 2021.
  • The JSE market capitalisation in billions (ZAR) for the week ending 5 March 2021 was R19,532.27.

The South African economy benefits from its diverse range of financial instruments, including a broad selection of commodities. These include coal, manganese, iron ore, gold, platinum, agricultural produce, and the like. South Africa is also a world-class tourist destination which contributes enormously to GDP. The problems faced by the country include, but are not limited to corruption, infrastructure collapse, failing parastatals, downgrading by international credit rating agencies, and negative GDP growth rates. Yet, despite this South Africa remains a premier EMEA country with tremendous stock, commodities, and cryptocurrency trading potential.

CFD stocks trading has gained momentum in recent years, with the widespread liberalisation of online trading activity. Top brokers like AvaTrade SA facilitate online CFD trading of stocks, and all the attendant benefits for traders. CFD leveraged trades are particularly exciting to SA traders, with generous leverage and low margin offered on a variety of financial instruments such as stocks, commodities, bonds, ETFs, and FX options. With CFD trading, clients at AvaTrade can benefit from rising and falling markets, provided the requisite trades are called correctly. By using MetaTrader 4 MetaTrader 5, and other popular selections such as ZuluTrade, and DupliTrade, SA clients can benefit all around. The low cost, low spread CFD trading options available through AvaTrade South Africa span multiple sectors and industries.

Leverage trading, also known as margin trading, is a system which allows the trader to open positions much larger than his own capital. The trader needs only to invest a certain percentage of the position, which is affected by many factors and changes between instruments, brokers and platforms. Leverage trading is popular amongst traders and brokers, and is a common trading system nowadays. “Leverage” usually refers to the ratio between the position value and the investment needed, and “Margin” is the percentage of the position needed.

Why Trade with Leverage

There are several advantages to trading with leverage, so much that is has become a common tool in the trading world.

  • Minimizes the capital the trader has to invest. Instead of paying the full price for an instrument, the trader can pay only a small portion of it. for instance – if a position’s value at the time of opening is $3,000; instead of paying the full amount, he can employ a leverage of 400:1 – meaning for every $400 in actual value he will be requested to invest $1 of his own capital. This mean that for this position he will need $7.5 to open it.
  • Some instruments are relatively cheap, meaning almost every trader can trade them easily. However, some are considered more prestigious, and based on their traded frequency and other factors are more expensive. Instead of investing large amounts in order to take part in their market, one can use leverage and enjoy the fluctuations in the price of those prestigious instruments.
  • While leverage trading, or margin trading, has less capital involved which can be a major advantage for many traders, it also comes with a loss risk. As one can gain much more than his initial investment, losses can occur on the same scale. It is important to keep track of opened positions, and apply stop loss and other market orders in order to prevent large scale losses.

Example of Leverage Trading – Retail Clients

For example, the price for one Troy ounce of Gold is $1,327. The trader believes the price is going rise and wishes to open a large buying position for 10 units. The full price for this position will be $13,270, which is not only a large amount to risk, but many traders do not possess such amounts. With a 20:1 leverage offered by AvaTrade South Africa, or a 5.00% margin, the amount will decrease substantially. Meaning that for every $20 of worth in the position, the trader will need to invest $1 out of his account, which comes to $663.5 only.

Money Management

When we decide to open a trading position, we first need to know what’s the applied margin, define a target, and define a maximum loss with a stop loss which will automatically decide our position in order to prevent losses by automatically closing the position. 

It is possible to define very easy risk management rules in order to avoid being negatively surprised by the leverage mechanism – notably, never risking more than 5% of your capital in a single operation.

How to choose the best leverage?

Choosing a suitable leverage depends on many factors. First and foremost, it depends on your money, but also on your capacity to manage risks, and your chosen trading style. If you trade on a short-term basis, your perspectives of gains are not very high. With scalping, traders’ gain targets are usually between 5 to 10 pips. As follows, in order to obtain maximum gains, it is necessary to use a large leverage. On the contrary, if the scope of your investment is rather long-term, for example in stocks, it is recommended to use a rather weak leverage in order to make sure that contrary movements on the market cannot eat up all of your invested money. To simplify and sum up what is important, in order to choose the best leverage, you have to study the volatility and define your investment period. Discover Avatrade’s demo account and enjoy free access to trading platforms with virtual money. In this way you’ll be able to trade and check your tests before investing any of your real money.

Losses higher than your deposits?

If you choose to use leveraging, it is important to understand that this can lead to losses higher than your capital in certain market situations. In fact, the increase in the size of your position thanks to the effect of leveraging will allow you to multiply your potential gains, but also your potential losses. In case you don’t have any more funds available, you can’t open any further financial positions. In such a case you’ll be able to choose to either fund your account in order to increase your available funds, or to close a part of your positions in order to decrease the need of coverage. If your open positions progress in the wrong direction, you may find yourself in a situation when your required coverage is higher than your current account balance and your available funds are negative. Such a situation will lead to a “margin call” from your financial intermediary who will ask you to either add funds or to clear a part of your positions. In case your situation isn’t re-established quickly, your intermediary will have the power to close all or a part of your positions by himself. In case of a violent movement (notably a gap), it is possible that yout intermediary is not capable of closing your position. In that case, you may end up with a negative account balance.

Dangers and disadvantages of Excessive Leverage

This is where the double-edged sword comes in, as real leverage has the potential to enlarge your profits or losses by the same magnitude. The greater the amount of leverage on the capital you apply, the higher the risk that you will assume. Note that this risk is not necessarily related to margin-based leverage although it can influence if a trader is not careful. Let’s illustrate this point with an example. Both Trader A and Trader B have a trading capital of US$10,000, and they trade with a broker that requires a 1% margin deposit. After doing some analysis, both of them agree that USD/JPY is hitting a top and should fall in value. Therefore, both of them short the USD/JPY at 120. Trader A chooses to apply 50 times real leverage on this trade by shorting US$500,000 worth of USD/JPY (50 x $10,000) based on their $10,000 trading capital. Because USD/JPY stands at 120, one pip of USD/JPY for one standard lot is worth approximately US$8.30, so one pip of USD/JPY for five standard lots is worth approximately US$41.50. If USD/JPY rises to 121, Trader A will lose 100 pips on this trade, which is equivalent to a loss of US$4,150. This single loss will represent a whopping 41.5% of their total trading capital.

The interest of using leverage

1. One significant advantage is that an appropriate usage of leverage allows the trader to avoid immobilizing all of his money on a trading account and instead to place the remaining part for example on an interest-bearing account. Not depositing the whole of your trading capital into your account can also be part of your risk management strategies.

2. Leveraging is mainly useful for adapting one’s risk taking in regard to the volatility of the market on which one is trading. Adjusting the leverage allows the trader to work with a constant range of risk, regardless of the volatility of the market.

On a market with low volatility, the trader can choose to artificially increase his position sizes thanks to leveraging in order to benefit from low level of variation. On the contrary, in the case of high volatility, the trader will choose to decrease the leverage utilized in order to decrease his exposure to the market.

Risk of Excessive Real Leverage in Forex Trading

Using real leverage in your forex trading is where the double-edged threat of leverage becomes a reality. Real leverage is able to magify your profits, but it can also magnify your losses by just as much. Too many beginning traders choose to ignore the possibility of losses when trading with real leverage. But in reality, the larger the amount of leverage that’s applied in relation to your capital, the greater the risk that is taken on. This is real leverage and the risk being discussed might not apply when a trader is using margin-based leverage, although it certainly can in some cases.

We can easily illustrate this by another example of traders who choose to trade using real leverage.

Our fictional traders, who we will call Trader A and Trader B, each have a trading capital of US$1,000, and their broker requires a 1% margin deposit on all leveraged trades. Both of them are interested in the USD/JPY, and both believe that the pair is near a top and is due for a correction. This leads them to short the pair at the 120.00 level.

Trader A uses 50 times real leverage on this theoretical trade by shorting $50,000 worth of USD/JPY (50 x $1,000).  This is based on the $1,000 trading capital they start with when opening their account. Because USD/JPY currently stands at 120.00 when the short trade is opened, one pip of USD/JPY for one standard lot is worth approximately US$8.30, so one pip of USD/JPY for five standard lots is worth approximately $41.50. If USD/JPY goes against this trader and rises to 121, Trader A will stand to lose 100 pips on the trade. That’s an equivalent loss of $415.00. This single loss is a drastic hit to the trading capital since it represents aneye-watering 41.5% of their total trading capital.

Trader B is a more cautious trader who decides to use just five times real leverage on the trade. They do this by shorting $5,000 worth of USD/JPY (5 x $1,000), which is based on the $1,000 trading capital deposited when they opened their account. That $5,000 worth of USD/JPY comes to just 5 percent or 1/20 of one standard lot. If USD/JPY rises to 121.00, Trader B would also lose 100 pips on the trade, however in dollar terms that’s only a loss of $41.5. It is still a disappointment, but in this case the loss represents just 4.15% of their trading capital. That’s far more acceptable, and allows the trader plenty of capital to place additional trades.

The table below shows a comparison of the impact of leverage on the accounts of the two traders:

Trader A

Trader B

Trading Capital

$1,000

$1,000

Real Leverage Used

50 times

5 times

Total Value of Transaction

$50,000

$5,000

In the Case of a 100-Pip Loss

-$415

-$41.5

% Loss of Trading Capital

41.5%

4.15%

% of Trading Capital Remaining

58.5%

95.8%

Margin Call – Retail Clients

In order to employ leverage, one needs to have sufficient funds in his account to cover possible losses. Each broker has different requirements, and AvaTrade ZA requires a Retail Trader to possess Equity of at least 50% of his Used Margin for MetaTrader 4 and AvaOptions accounts. Going back to the example above, the position’s original value is $13,270; for both MetaTrader 4 and FX options trading accounts, with leverage the trader invested $663.5 of his capital, and if he has 50% of this used margin in equity, i.e. $331.75, his positions will be kept opened. If, however, the trader has losses and his Equity drops below 50% of used margin on MetaTrader 4 and AvaOptions accounts, the broker will shut down the client’s position(s), which is called a “Margin Call”. On AvaOptions all the client’s positions will be closed, while MetaTrader 4 will shut down the largest losing position first, and will continue to close positions until the equity level returns above 50% of the used margin.

Example of Leverage Trading – Pro/Non – EU clients

For example, the price for one Troy ounce of Gold is $1,327. The trader believes the price is going rise and wishes to open a large buying position for 10 units. The full price for this position will be $13,270, which is not only a large amount to risk, but many traders do not possess such amounts. With a 200:1 leverage offered by AvaTrade South Africa, or a 0.50% margin, the amount will decrease substantially. Meaning that for every $200 of worth in the position, the trader will need to invest $1 out of his account, which comes to $66.35 only.

Margin Call – Pro/Non – EU clients

In order to employ leverage, one needs to have sufficient funds in his account to cover possible losses. Each broker has different requirements, and AvaTrade ZA requires a Retail Trader to possess Equity of at least 50% of his Used Margin for MetaTrader 4 and AvaOptions accounts. Going back to the example above, the position’s original value is $13,270; for both MetaTrader 4 and FX options trading accounts, with leverage the trader invested $663.5 of his capital, and if he has 50% of this used margin in equity, i.e. $331.75, his positions will be kept opened. If, however, the trader has losses and his Equity drops below 50% of used margin on MetaTrader 4 and AvaOptions accounts, the broker will shut down the client’s position(s), which is called a “Margin Call”. On AvaOptions all the client’s positions will be closed, while MetaTrader 4 will shut down the largest losing position first, and will continue to close positions until the equity level returns above 50% of the used margin.

Leverage Trading with AvaTrade South Africa

AvaTrade ZA offers many instruments, and each has a different leverage which can also change based on the chosen platform by the trader. On MetaTrader4 and MetaTrader 5 you can enjoy an up to leverage. Most forex pairs have the highest leverage, some metals such as gold are , crude oil trading as well as silver trading and other metals is limited to leverage. It is important to make sure the leverage on the specific platform before you commence you trades, and in order to avoid a margin call always make sure you have enough equity in your account’s balance so you can continue your trades undisturbed.

How to start?

How to do it in practice? To trade online using CFD contracts, it is first necessary to open a trading account with Ava Trade and deposit a minimum of 100 euros. 

One of the best brokers in CFD regulated in South Africa is Avatrade. Avatrade has a highly performing CFD and Forex trading platform which allows you to trade more than 250 instruments with a single trading account. A CFD trading account opened with Avatrade is not a custody account nor a PEA because CFD transactions are not closed by transfers of securities. 

Hence, we cannot really speak of buying or selling in the case of CFD contracts. In fact, you are not really buying assets, rather, you are trading on their difference, as suggested by their name.

Leverage main FAQs

  • Can leverage cause my account go negative?

    Because AvaTrade South Africa uses a 50% margin requirement and the use of the margin call your risk of excessive trading losses that exceed the total balance of your account is minimized, but it is not eliminated completely. During a period of extreme volatility, it is possible that a position could move so rapidly against you that it is not possible to liquidate a losing position in time to keep your account balance from going negative. To avoid this, we strongly recommend that you manage your use of leverage wisely.

     
  • What is the difference between leverage and margin?

    While leverage and margin are closely interconnected, they are not the same thing. Both do involve borrowing in order to trade in the financial markets, however leverage refers to the act of taking on debt, while margin is the actual money or debt that the trader has taken on to invest in financial markets. So, leverage is referred to as a ration, such as 1:30 or 1:100, which indicates how much debt can be taken on to open a position, while margin is referred to as the actual amount borrowed to create the leverage. For example, with 1:100 leverage you can control $100 of an asset with only $1 in margin.

     
  • Are there any disadvantages of leverage?

    Leverage is a very complex financial tool and should be respected as such. While it sounds fantastic in theory, the reality can be quite different once traders come to realize that leverage doesn’t only magnify gains, but it also magnifies losses. Any trade using leverage that moves against the trader is going to create a loss that is much larger than it would have been without the use of leverage. This is why caution is recommended until more experience with leverage is gained. This can lead to a longer and more prosperous trading career.