Leverage is a fancy word for debt. A company that owes a lot of other organizations money is considered “highly leveraged”. The most common forms of leverage are bank loans and corporate bonds. For an everyday investor, using leverage could mean borrowing money in order to buy something very expensive, like an apartment building complex. It could also mean using margin to buy stocks through a discount broker. While using leverage can multiply returns dramatically, it’s a risky strategy that can eat one’s capital very quickly. First, investors need to pay interest on the margin they use as long as they hold a position, with no way of predicting when their investment thesis will be confirmed by the market. Second, in the event of a sudden drop of the value of the securities they bought using borrowed money (a leveraged position), an investor can potentially lose everything.
If your cousin Jimmy who works at Air Canada tells you that the airline’s sales are going through the roof, and no one else outside the company knows about it yet, you might be tempted to buy the company’s stock to get rich quick. Read more