How leverage works
Suppose you invest £10,000 of your own money and borrow another £10,000, giving you £20,000 of market exposure. This is 2x leverage. If the market rises 10%, your £20,000 becomes £22,000 — but after repaying the £10,000 loan, you have £12,000, a 20% return on your £10,000 of equity. If the market falls 10%, your £20,000 becomes £18,000 — after repaying the loan, you have £8,000, a 20% loss. Leverage doubles the amplitude of your outcome in both directions.
Forms of leverage in investing
Leverage comes in many forms: margin lending (borrowing from your broker to buy more stock); leveraged ETFs (funds designed to deliver 2x or 3x daily market returns); options (small premiums control large notional values); futures contracts (you control a large position with a small margin deposit); and corporate leverage (buying a company with borrowed money, as in an LBO). Each has different mechanics, costs, and risk profiles.
The margin call: when leverage kills
When you use borrowed money and the investment falls below a threshold, your broker issues a margin call — requiring you to deposit more cash or liquidate positions. If you can't meet the margin call, the broker sells your assets at the worst possible time (when prices are already low), crystallising losses. This is how retail investors lose everything during crashes — not just the decline in value, but forced selling at the bottom.
Historical disasters: leverage gone wrong
Long-Term Capital Management (LTCM) — a hedge fund run by Nobel laureates — levered its positions 25-to-1 before Russia's 1998 default caused correlations to spike and the fund to collapse, requiring a Federal Reserve-orchestrated bailout. Archegos Capital lost $10+ billion in 2021 through highly leveraged stock positions via total return swaps. The pattern is consistent: leverage works until it doesn't, and when it fails it does so suddenly and completely.
"Leverage is the ability to make someone else's mistake yours." — a trader's warning about borrowed capital
What this means for you
For most long-term individual investors, leverage is unnecessary and dangerous. The stock market already offers excellent returns without it. If you use leveraged products, ensure you fully understand the liquidation risk, the cost of borrowing (which erodes returns), and the "volatility decay" in leveraged ETFs (which causes them to lose value even in flat markets over time). The most appropriate use of leverage for ordinary investors is a sensible mortgage on a primary residence — not speculative trading.