Leverage is the use of borrowed capital to increase the potential return on an investment. By using leverage, investors can control larger positions with less of their own money, amplifying both gains and losses.
For example, if you invest $10,000 of your own money and borrow an additional $10,000, you have $20,000 to invest with 2:1 leverage. If your investment gains 10%, you earn $2,000 — a 20% return on your original $10,000.
However, leverage is a double-edged sword. If the investment loses 10%, you lose $2,000 — also a 20% loss on your capital. In extreme cases, leveraged investors can lose more than their initial investment. Leverage is commonly used in real estate, margin trading, and derivatives.