The power hour is a period of active trading, high volume, and volatility that tends to occur when the market opens and again when it closes. Many short-term traders find the power hour appealing because of the trading opportunities it presents.
Power hour trading generally isn’t as compelling to buy-and-hold and longer-term investors, as these short-term trades come with much higher risk exposure, despite the opportunity for gains.
Key Points
• The “power hour” refers to periods of high trading activity, volume, and volatility typically at the market’s open and close.
• While appealing to short-term traders, power hour trading carries more risk for longer-term investors.
• The first hour of trading is active due to reactions to overnight news, while the last hour sees increased activity as traders look to close positions or capitalize on heightened selling.
• Triggers for intense power hour trading include earnings reports, news about “daily gainers,” major economic news, and quarterly triple witching hour events.
• Due to increased volatility and risk, it is advisable for investors unfamiliar with choppy markets to avoid power hour trading.
What Is the Stock Market Power Hour?
During the trading day, the power hour is when traders have a concentrated time to leverage specific market opportunities. That goes for anyone trading common market securities like stocks, index funds, commodities, currencies, and derivatives, especially options trading and futures.
The power hour period typically occurs when the market opens at 9:30am ET and lasts until approximately 10:30am. Some traders identify a second power hour at the end of the day: roughly 3:30pm to 4:30pm, when the market closes.
The heightened activity during these periods comes from a confluence of factors.
• Traders digest recent news and upcoming events.
• They place new trades and look for opportunities.
The term power hour is subjective, but most market observers land on two specific times in defining the term:
• The first trading hour of the market day. This is when news flows in overnight from across the world that can impact portfolio positions that investors may want to leverage, when investing online or using a brokerage.
• The last hour of the trading day. This is when sellers may be anxious to close a position for the day, and buyers trading stocks may be in a position to pounce and buy low when selling activity is high.
One commonality between the first hour of a stock market trading session and the last hour is that trading volatility tends to be higher than it is during the middle of a normal trading day. That’s primarily because traders are looking to buy or sell when demand for trading is robust, and that usually happens at or near the market opening or the market close.
Each power hour brings something different to the table, when it comes to potential investing opportunities.
The first hour of any trading session tends to be the most active, as traders react to overnight news and data numbers and stake out advantageous positions.
For example, an investor may have watched financial or business news the previous night, and is now reacting to a story, interview, or prediction.
Some traders refer to this scenario as “stupid money” trading, as conventional wisdom holds that one news event or headline shouldn’t sway an investor from a strategy-guided long-term investment position. The fact is, by the time the average investor reacts to overnight data, it’s likely the chance for profit is already gone.
Here’s why: Most professional day traders were likely already aware of the news, and have already priced that information into their portfolios. As the price goes up on a stock based on artificial demand, the professional traders typically step in and take the other side of the trade, knowing that in the long run, investing money will drift back to the original trade price for the stock and the professional investor will likely end up making money.
Power Hour End of Day
The last hour of the trading day may also come with high market volatility, which tends to generate more stock trading. Many professional traders tend to trade actively in the morning session and step back during mid-day trading, when volatility is lower and the market is quieter than in the first and last hours of the day.
Regular traders can perk up at the last hour of trading, where trading is typically more frequent and the size of trades generally climb as more buyers and sellers engage before the trading session closes out. Just as in the first hour of the trading day, amateur investors tend to wade into the markets, buying and selling on the day’s news.
That activity can attract bigger, more seasoned traders who may be looking to take advantage of ill-considered positions by average investors, which increases market trading toward the close.
Red Flags and Triggers to Look for During Power Hour Trading
For any investor looking to gain an advantage during power hour trading, the idea is to look for specific market news that can spike market activity and heighten the chances of making a profit in the stock market.
These “triggers” may signal an imminent power hour market period, when trading can grow more volatile.
Any Earnings Report
Publicly-traded companies are obligated to release company earnings on a quarterly basis. When larger companies release earnings, the news has a tendency to move the financial markets. Depending on whether the earnings news comes in the morning or after hours, investors can typically expect higher trading to follow. That could lead to heavier power hour trading.
News on Big “Daily Gainers”
Stock market trading activity can grow more intense when specific economic or company news pushes a single large stock — or stock sector — into volatile trading territory.
For instance, if a technology company X announces a new product release, investors may want to pounce and buy that tech stock, hoping for a significant share price uptick. That can lead to higher volume trading stock X, making the company and the market more volatile (especially later in the day), thus ensuring an active power hour trading time.
Reserve/Economic News
Major economic news, like jobs reports, consumer sentiment, inflation rates, and gross domestic product (GDP) reports, are released in the morning. Big news from the Federal Reserve typically comes later in the day, after a key speech by a Fed officer or news of an interest rate move after a Fed Open Markets Committee meeting.
Make no mistake, news on both fronts can be big market movers, and can lead to even more powerful power hour trading sessions.
Anticipation of huge economic news, like a Federal Reserve interest rate hike or the release of the U.S. government’s monthly non-farm labor report, can move markets before the actual news is released, potentially fueling an even larger trading surge after the news is released, either at the open (for government economic news) or at the end of the trading day (for Federal Reserve news).
Triple Witching Hour Events
Quarterly triple witching hours — when stock options, futures and index contracts expire on four separate Fridays during the year — historically have had a substantial impact on market activity on those Friday afternoons, in advance of the contracts expiring at the days’ end.
When options contracts involving larger companies expire, market activity on a Friday afternoon prior to closing can be especially volatile. Thus, any late afternoon power hour on a triple-witching-hour Friday can be highly active, and may be one of the largest drivers of power hour trading during the year.
The Takeaway
The concept of a stock market “power hour” is based on the increased activity at certain times of day — typically the market’s open and close. While the power hour presents opportunities for some traders, others may find it risky.
Consequently, it’s a good idea to give power hours a wide berth if you’re not familiar with trading in choppy markets, where the risk of losing money is high when power trading activity is at its highest.
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FAQ
Is the power hour a good time to trade?
For sophisticated short-term traders, trading power hour stocks can be advantageous. The heightened market activity often presents a number of opportunities. For those less skilled at maximizing these short windows of opportunity, power hour trading can be highly risky.
Is the power hour more volatile?
Yes, the hallmark of the power hour, whether at the market’s open or close, is its volatility. In short, the power hour is a high-risk time in the market for most ordinary investors.
Can you make money during the power hour?
It’s possible to make money during the power hour, assuming you have the skill and the strategies to seize the opportunities presented by short-term price movements.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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NBBO — the National Best Bid and Offer — is a quote available marketwide that represents the tightest composite spread for a security, e.g., the highest bid price and the lowest ask price for that security trading on various exchanges.
The NBBO is a regulation put in place by the Securities and Exchange Commission (SEC) that requires brokers who are working on behalf of clients to execute a trade at the best available ask price, and the best available bid price.
Brokers must guarantee at least the NBBO to their clients at the time of a trade, per SEC rules.
Key Points
• The National Best Bid and Offer (NBBO) is a marketwide quote for the highest bid price and the lowest ask price for a security across exchanges.
• The SEC enacted the NBBO regulation to ensure brokers execute trades for clients at the best available bid and ask prices (the bid-ask spread).
• The bid-ask spread is the difference between the price an investor is willing to buy (bid) and the price a seller is willing to sell (ask).
• Securities Information Processors (SIPs) continuously process bid and ask prices to calculate and update the NBBO.
• There can be a slight lag in real-time data due to the high volume of transactions, which the SEC addresses with intermarket sweep orders (ISO).
How Does “Bid vs Ask” Work in the Stock Market
In order to understand NBBO, investors need to understand the bid-ask price of a security, such as a stock. This is also known as the spread (two of many terms investors and traders should know). If an investor is “bidding,” they’re looking to buy. If they’re “asking,” they’re looking to sell. It may be helpful to think of it in terms of an “asking price,” as seen in real estate.
The average investor or trader will typically see the bid or ask price when looking at prices for different securities. Most of the bid-ask action takes place behind the scenes, and it’s happening fast, landing on an average price. These are the prices represented by stock quotes.
That price is the value at which brokers or traders are required to guarantee to their customers when executing orders. NBBO requires brokers to act in the best interest of their clients.
The National Best Bid and Offer (NBBO) is effectively a consolidated quote of the highest available bid and the lowest available ask price of a security across all exchanges. NBBO was created by the SEC to help ensure that brokers offer customers the best publicly available bid and ask prices when investors buy stocks online or through a traditional brokerage.
NBBO Example
Let’s run through a quick example of how the NBBO might work in the real world.
Let’s suppose that a broker has a few clients that want to buy stock:
• Buyer 1 puts in an order to the broker to buy shares of Company X at $10
• Buyer 2 puts in an order to the broker to buy shares of Company X at $10.50
• Buyer 3 puts in an order to the broker to buy shares of Company X at $11
Remember, these are “bids” — the price at which each client is willing to purchase a share of Company X.
On the other side of the equation, we have another broker with two clients that want to sell their shares of Company X, but only if the price reaches a certain level:
• Client 1 wants to sell their shares of Company X if the price hits $12
• Client 2 wants to sell their shares of Company X if the price hits $14
In this example, the NBBO for Company X is $11/$12. Why? Because these are the best bid vs. ask prices that were available to the brokers at the time. This is, on a very basic level, how calculating the NBBO for a given security might work.
Because the NBBO is updated constantly through the day with offers for stocks from a number of exchanges and market players, things need to move fast.
Most of the heavy lifting in NBBO calculations is done by Securities Information Processors (SIPs). SIPs connect the markets, processing bid and ask prices and trades into a single data feed. They were created by the SEC as a part of the Regulation National Market System (NMS).
There are two SIPS in the U.S.: The Consolidated Tape Association (CTA) , which works with the New York Stock Exchange, and the Unlisted Trading Privileges (UTP) , which works with stocks listed on the Nasdaq exchange.
The SIPS crunch all of the numbers and data to keep prices (NBBO) updated throughout the day. They’re incredibly important for traders, investors, brokers, and anyone else working in or adjacent to the markets.
Is NBBO Pricing Up to Date?
The NBBO system may not reflect the most up-to-date pricing data. Bid, ask, and transaction data is changing every millisecond. For high-frequency traders that are making fast and furious moves on the market, these small price fluctuations can cost them.
To make up for this lag time, the SEC allows trading via intermarket sweep orders (ISO), letting an investor send orders to multiple exchanges in order to execute a trade, regardless of whether a price is the best nationwide.
The Takeaway
NBBO represents the crunching of the numbers between the bid-ask spread of a security, and it’s the price you’ll see listed on a financial news network or stock quote.
The NBBO adds some legal protection for investors, effectively forcing brokers to execute trades at the best possible price for their clients.
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FAQ
What does NBBO mean in trading?
The National Best Bid and Offer (NBBO) is a marketwide quote for the highest bid price and the lowest ask price available for a security, across exchanges. That means it’s a composite or consolidated quote that ensures investors are getting the best available price for a security.
What is Level 2?
Level 2 is a subscription-based service offered by Nasdaq that gives traders access to live trading data from the exchange, including bid-ask spreads and order sizes from market makers. Level 2 offers more in-depth information about pricing than NBBO, which is part of a Level 1 trading screen.
What is the advantage of NBBO?
First and foremost, NBBO helps protect investors, by ensuring the tightest spreads for securities prices. As such, NBBO also promotes market transparency and competition.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
This article is not intended to be legal advice. Please consult an attorney for advice.
A money purchase pension plan or MPPP is an employer-sponsored retirement plan that requires employers to contribute money on behalf of employees each year. The plan itself defines the amount the employer must contribute. Employees may also have the option to make contributions from their pay.
Money purchase pension plans have some similarities to more commonly used retirement plans such as 401(k)s, traditional pension plans, and corporate profit-sharing plans. If you have access to a MPPP plan at work, it’s important to understand how it works and where it might fit into your overall retirement strategy.
Key Points
• A Money Purchase Pension Plan (MPPP) is an employer-sponsored retirement plan in which employers make fixed, pre-determined contributions to the plan on behalf of all employees.
• MPPP contribution limits are $70,000 annually in 2025, or 25% of compensation, whichever is less.
• Contributions to MPPPs grow tax-free for employees and are tax-deductible for employers.
• MPPP distribution options include a lifetime annuity and a lump sum distribution.
• MPPP advantages include large account balances and tax benefits, but disadvantages include no hardship withdrawals and no catch-up contributions.
What Is a Money Purchase Pension Plan?
Money purchase pension plans are a type of defined contribution plan. That means they don’t guarantee a set benefit amount at retirement. Instead, these retirement plans allow employers and/or employees to contribute money up to annual contribution limits.
Like other retirement accounts, participants can make withdrawals when they reach their retirement age, which can be an important part of their retirement planning. In the meantime, the account value can increase or decrease based on investment gains or losses.
Money purchase pension plans require the employer to make predetermined fixed contributions to the plan on behalf of all eligible employees. The company must make these contributions on an annual basis as long as the plan is maintained.
Contributions to a money purchase plan grow on a tax-deferred basis. Employees do not have to make contributions to the plan, but they can choose to do so.
What Are the Money Purchase Pension Plan Contribution Limits?
Each money purchase plan determines what its own contribution limits are, though the amount can’t exceed maximum limits set by the IRS. For example, an employer’s plan may specify that they must contribute 5% or 10% of each employee’s pay into that employee’s MPPP plan account.
Annual money purchase plan contribution limits are similar to SEP IRA contribution limits. For 2025, the maximum contribution amount allowed is the lesser of:
• 25% of the employee’s compensation, OR
• $70,000
The IRS routinely adjusts the contribution limits for money purchase pension plans and other qualified retirement accounts based on inflation. The amount of money an employee will have in their money purchase plan upon retirement depends on the amount that their employer contributed on their behalf, the amount the employee contributed, and how their investments performed. Your account balance may be one factor in determining when you can retire.
Rules for money purchase plan distributions are the same as other qualified plans — you can begin withdrawing money penalty-free starting at age 59 ½. If you take out money before that, you may owe an early withdrawal penalty.
Like a pension plan, money purchase pension plans must offer the option to receive distributions as a lifetime annuity. Money purchase plans can also offer other distribution options, including a lump sum. Participants do not pay taxes on their accounts until they begin making withdrawals.
The Pros and Cons of Money Purchase Pension Plans
Money purchase pension plans have some benefits, but there are also some drawbacks that participants should keep in mind.
Pros of Money Purchase Plans
Here are some of the advantages for employees and employers who have a money purchase pension plan.
• Tax benefits. For employers, contributions made on behalf of their workers are tax deductible. Contributions grow tax-free for employees, allowing them to defer taxes on investment growth until they begin withdrawing the money.
• Loan access. Employees may be able to take loans against their account balances if the plan permits it.
• Potential for large balances. Given the relatively high contribution limits, employees may be able to accumulate account balances higher than they would with a 401(k) retirement plan, depending on their pay and the percentage their employer contributes on their behalf.
• Reliable income in retirement. When employees retire and begin drawing down their account, the regular monthly payments through a lifetime annuity may help with budgeting and planning.
Disadvantages of Money Purchase Pension Plan
Most of the disadvantages associated with money purchase pension plans impact employers rather than employees.
• Expensive to maintain. The administrative and overhead costs of maintaining a money purchase plan can be higher than those associated with other types of defined contribution plans.
• Heavy financial burden. Since contributions in a money purchase plan are required (unlike the optional employer contributions to a 401(k)), a company could run into issues in years when cash flow is lower.
• Vesting schedules may be long. Employees who leave the company before they are fully vested in an MPPP may forfeit some or all of their employer’s contributions.
• No catch-up contributions for older employees. Unlike a 401(k), employees ages 50 and up do not have the option to make an additional annual catch-up contribution to an MPPP.
Money Purchase Pension Plan vs 401(k)
The main differences between a pension vs 401(k) have to do with their funding and the way the distributions work. In a money purchase plan, the employer provides the funding with optional employee contribution.
With a 401(k), employees fund accounts with elective salary deferrals and optional employer contributions. For both types of plans, the employer may implement a vesting schedule that determines when the employee can keep all of the employer’s contributions if they leave the company. Employee contributions always vest immediately.
The total annual contribution limits (including both employer and employee contributions) for these defined contribution plans are the same, at $70,000 for 2025. But 401(k) plans allow for catch-up contributions made by employees aged 50 or older. For 2025, the total employee contribution limit is $23,500 with an extra catch-up contribution of $7,500, and for those aged 60 to 63, there’s a catch-up contribution of $11,250 (instead of $7,500), thanks to SECURE 2.0.
Both plans may or may not allow for loans, and it’s possible to roll amounts held in a money purchase pension plan or a 401(k) over into a new qualified plan or an Individual Retirement Account (IRA) if you change jobs or retire.
Employees may also be able to take hardship withdrawals from a 401(k) if they meet certain conditions, but the IRS does not allow hardship withdrawals from a money purchase pension plan.
Here’s a side-by-side comparison of a MPPP and a 401(k):
MPPP Plan
401(k) Plan
Funded by
Employer contributions, with employee contributions optional
Employee salary deferrals, with employer matching contributions optional
Tax status
Contributions are tax-deductible for employers, growth is tax-deferred for employees
Contributions are tax-deductible for employers and employees, growth is tax-deferred for employees
Contribution limits (2025)
For 2025, lesser of 25% of employee’s pay or $70,000
For 2025, $23,500, with catch-up contribution of $7,500 for employees 50 or older, and $11,250 SECURE 2.0 catch-up for those 60 to 63
Catch-up contributions allowed
No
Yes, for employers 50 and older
Loans permitted
Yes, if the plan allows
Yes, if the plan allows
Hardship withdrawals
No
Yes, if the plan allows
Vesting
Determined by the employer
Determined by the employer
The Takeaway
Money purchase pension plans can be a valuable tool for employees to reach their retirement goals. They’re similar to 401(k)s, but there are some important differences.
Whether you save for retirement in a money purchase pension plan, a 401(k), or another type of account, the most important thing is to get started. The sooner you begin saving for retirement, the more time your money will potentially have to grow.
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FAQ
What is a pension money purchase plan?
A money purchase pension plan or money purchase plan is a defined contribution plan that allows employers to save money on behalf of their employees. These plans are similar to profit-sharing plans, and companies may offer them alongside a 401(k) plan as part of an employee’s retirement benefits package.
Can I cash in my money purchase pension?
You can cash in a money purchase pension at retirement in place of receiving lifetime annuity payments. Otherwise, early withdrawals from a money purchase pension plan are typically not permitted, and if you do take money early, taxes and penalties may apply. However, if you leave your job, you can roll over the amount of money for which you are fully vested into an IRA or a new employer’s 401(k).
Is a final salary pension for life?
A final salary pension is a defined benefit plan. Unlike a defined contribution plan, defined benefit plans pay out a set amount of money at retirement, typically based on your earnings and number of years of service. Final salary pensions can be paid as a lump sum or as a lifetime annuity, meaning you get paid for the remainder of your life.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Using leverage is a common trading strategy whereby qualified investors borrow cash to increase their trading power. Thus, investors can leverage a small amount of capital to get exposure to a much bigger position.
For example, a leverage ratio of 20:1 means a $1 investment can buy $20 worth of an asset.
To use leverage, qualified traders must open a margin account with a brokerage in order to place bigger bets, and potentially earn higher returns on their initial capital. (The terms leverage and margin are often used interchangeably.)
However, leveraged trading also significantly increases a trader’s risk of losses. If the asset moves in the wrong direction, the trader not only suffers a loss but must repay the amount borrowed, plus interest and fees.
This is one reason that only experienced investors qualify for margin accounts and leverage trading opportunities.
Key Points
• Leverage trading is a high-risk strategy that involves using borrowed funds to amplify buying power to seek potentially higher returns.
• To use leverage, traders must qualify to open a margin account. Leverage trading or trading on margin are often used interchangeably.
• By using a small amount of capital to place bigger bets, traders may see bigger returns. Risks include the potential to lose more than the initial investment.
• Not all securities are eligible for leverage; rules vary by broker and security type.
• Leverage is typically reserved for qualified investors, due to its high risk.
What Is Leverage Trading?
In both business and finance, the term leverage refers to the use of debt to power an expansion or purchase securities. With leverage trading, traders can use a margin account to borrow funds in order to take bigger positions with assets like stocks, derivatives, and foreign currencies (forex).
A margin account allows qualified traders to borrow from a brokerage to purchase securities that are worth more than the cash they have on hand. In this case, the cash or securities already in the trader’s account act as collateral.
What Is Margin, How Does It Work?
Leverage and margin are related but different concepts. For example, a trader can use margin to increase their leverage. Margin is the tool, and leverage is the force behind the tool, which can be used to potentially increase returns (or losses).
Not all investors can open a margin account, however, and different brokerages may have different margin requirements.
To start, an investor must complete a margin agreement with their brokerage, and remain compliant with a number of industry rules. For example, most margin accounts require a $2,000 minimum deposit (the minimum margin).
Once the margin feature is added to the investor’s account, that part of their account falls under the rules of FINRA, the Federal Reserve Board, the Securities and Exchange Commission (SEC), and exchanges such as the NYSE, as well as the policies of the brokerage itself.
Margin rules for equity trades, for example, require that the investor maintain 50% of the value of a trade in their margin account (per the Fed’s Regulation T) — a 2:1 ratio. The margin requirements for other securities, like forex and futures contracts, are much lower and allow for higher leverage (e.g., 3% to 15%).
Which Securities Are Eligible for Margin?
Not all securities can be bought using leverage, however. Industry rules dictate that equities known as penny stocks, as well as Initial Public Offering (IPO) stocks, and other volatile and illiquid securities, are not marginable.
Generally, stocks and exchange-traded funds (ETFs) that are worth more than $3 per share, as well as mutual funds and certain types of bonds, are eligible for leverage trades using margin. Check with your broker, as rules can vary by jurisdiction.
Forex options trading, for example, allows traders to take a larger position using very small amounts of cash. While there is no standard amount of margin in the forex market, it is common for traders to post 1% margin, which allows them to trade $100,000 of notional currency for every $1,000 posted — a ratio of 100:1.
Leverage Risks and Rewards
Leverage trading can only be successful if the return on an investment is higher than the cost to borrow money, which you must repay with interest and fees.
Leverage trading can significantly increase potential earnings, but it is also very risky because you can lose more than the entire amount of your investment. For that reason leverage is usually only available to experienced traders.
What Is Pattern Day Trading?
Pattern day trading is a type of trading style that typically requires a much higher initial margin amount. Someone would be flagged as a pattern day trader if they make four or more day trades during a period of five business days — and if those trades amount to more than 6% of their overall trading activity.
Day trading refers to those who buy and sell a single security within one day. It’s a high-risk strategy that some traders employ to profit from very short-term price movements.
Once a trader is identified as a pattern day trader, per FINRA rules, they must keep a minimum of $25,000 in cash and/or equity in their margin account.
FINRA established the Pattern Day Trader Rule to limit risk-taking among day traders, by requiring firms to impose these restrictions.
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The use of leverage has a long history in the world of trading and finance.
Ancient Uses of Leverage
There is evidence that a form of leverage trading first emerged in ancient civilizations, often through the exchange of commodities. Traders could put down a small amount of money as a deposit on a share of a future crop or herd of cattle, for example.
Another more rudimentary form of leverage enabled merchants to raise money for an expedition from investors, who would invest smaller amounts with the hope of greater profits from the expedition, assuming the trip was successful.
Over the centuries, the use of leverage became more sophisticated, enabling the creation of various types of derivatives, including futures contracts.
Leverage in the 20th-Century
Over time leverage ratios became quite high, and they were not well regulated until the stock market crash of 1929. That event forced a reassessment of restrictions around the use of leverage.
For a period of time starting in the mid-20th century, leveraged buyouts became a popular business acquisition strategy. As it sounds, leveraged buyouts involve the use of borrowed capital to buy out an existing company, and then use different strategies to turn it around and make a profit.
Leveraged buyouts are still a common private equity strategy, but they can often fail.
Today, thanks to advances in technology and stronger regulations, allowable leverage ratios and rules governing margin accounts are subject to greater oversight.
How Leverage Works in Trading
Leverage trading consists of a trader borrowing money from a broker using margin, then using the borrowed funds along with their own money to enter into trades.
The key to understanding how using leverage can potentially help generate higher returns, but also greater losses, is that the margin funds are a fixed liability.
Suppose a trader starts with $50, and borrows $50 to buy $100 worth of stock. Whether the stock’s value goes up or down from there, the trader is on the hook to repay the $50, plus interest and any related fees, to the broker.
💡 Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.
Example of Leverage Trading
Using the above example, suppose the stock appreciates by 10%, for a total of $110, and the trader closes out the position. They return the $50 they borrowed, and keep the remaining $60. That equates to a $10 gain on their $50 of capital, and a 20% return — double the return of the underlying stock, before fees and expenses.
Now, consider what happens if the stock declines in value by 10%. The trader closes out the position and receives $90, but has to give the broker back the $50 they borrowed, plus interest and fees. They are left with $40, a loss of $10, plus the margin expenses, which is a 20% loss or more.
Understanding Leverage Ratio
Leverage is often expressed as a ratio. For example, a leverage ratio of 2:1 is generally the rule for using margin for equity trades. If you have $50, you can buy $100 worth of stock.
In the case of other types of securities, the leverage ratio can be much higher. A leverage ratio of 20 means a $1,000 investment would allow you to open a trading position of $20,000; 50:1 would allow you to take a position of $50,000.
Maximum Leverage
Brokers have limits on how much they’ll lend traders based on the amount of funds the trader has in their account, their own regulations, and government regulations around leverage trading. If you’re considering using leverage, be sure to understand the rules.
• Stocks. Thanks to the Federal Reserve Board’s Regulation T, plus a FINRA rule governing margin trades in brokerage accounts, the maximum you can borrow is 50% for an equity trade.
• Forex. The foreign currency market tends to allow greater amounts of leverage. In some cases, as high as 100:1 in the U.S.
• Commodities. Commodities rules around maximum leverage and leverage ratios can fluctuate based on the underlying asset.
Pros and Cons of Leveraged Trading
On the surface, leverage may sound like a powerful tool for investors — which it can be. But leverage can be a double-edged sword: Leverage can add to buying power and potentially increase returns, but it can also magnify losses, and put an investor in the hole.
Pros
Using leverage can increase your trading power, sometimes to a large degree. It’s important to know the rules, as leverage ratios vary according to the securities you’re trading, the jurisdiction you’re in, and sometimes your broker’s discretion.
If you meet the criteria for using leverage or opening a margin account to trade, it’s relatively easy to access the funds and open bigger positions. Sometimes, placing that bigger bet can pay off with a much higher return than you would have gotten if you invested just the capital you had on hand.
Cons
Just as using leverage can amplify gains, it can amplify losses — in some cases to the point where you lose your initial investment, you must repay the money you borrowed, and you may owe fees and interest on top of that.
For that reason, many brokers require investors to meet certain criteria before they can open a margin account and place leveraged trades.
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Pros of Leverage:
• Increases buying power
• Potential to earn higher returns
• Relatively easy to use, if you qualify
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Cons of Leverage:
• Leverage funds must be repaid, with interest
• Potential to lose more than your initial investment
• Investors must meet specific criteria in order to use leverage or open a margin account
Types of Leverage Trading
There are a few different types of leverage trading, each with similarities and differences.
Trading on Margin
As noted, margin is money that a trader borrows from their broker to purchase securities. They use the other securities in their account as collateral for the loan.
If a leveraged trade goes down in value, a trader may be subject to a margin call. This means they will need to sell other securities to cover the loss, or deposit enough funds to meet the margin minimum. Failing that, a brokerage could sell other securities from the investor’s account.
Many brokers charge interest on margin loans. So in order for a trader to earn a profit, the security has to increase in value enough to cover the interest.
Leveraged ETFs
Some ETFs use leverage to try and increase potential gains based on the index they track. For example, there is an ETF that specifically aims to return 3x the returns that the regular S&P 500 index would get.
It’s important to note that most funds reset on a daily basis. The leveraged ETF aims to match the single day performance of the underlying index. So over the long term even if an index increases in value, a leveraged ETF might decrease in value.
Derivatives
Traders can also use leverage trading with derivatives and options contracts, although leverage in these cases looks quite different.
For example, using leverage with futures contracts is not considered a loan, exactly; it’s called a performance bond. The investor puts down a good faith deposit (the initial margin) in order to control a desired position. Once the position is open, the required or maintenance margin must be met. The terms of that contract are determined by the exchange.
Buying a single option contract lets a trader control many shares of the underlying security — generally 100 shares — for far less than the value of those 100 shares. As the underlying security increases or decreases in value, the value of the options contract changes.
Options trading is highly risky and generally recommended only for experienced traders.
Forex Leverage
Forex trading allows even more leverage than futures contracts. That said, leverage ratios vary by the type of currency pairs being traded. In addition, a broker may have different margin requirements depending on the size of the trade overall, as well as the potential volatility of the currencies involved in the trade.
There are several key terms to know in order to fully understand leverage trading.
Account balance: The total amount of funds in a trader’s account that are not currently in trades.
Buying power: This is the total amount a trader has available to enter into leverage trades, including both their own capital and the amount they can borrow.
Coverage: The ratio of the amount of funds currently in leveraged trades in one’s account to the net balance in their account.
Margin Requirement: This is the amount of funds a brokerage requires a trader to have in their margin account when entering into leverage trades. If a trader incurs losses, those funds will be used to cover them. Traders can also use securities they hold in their account to cover losses.
Margin call: If a trader’s account balance falls below the margin requirement, the broker will issue a margin call. This is a warning telling the trader they have to either add more funds to their account or close out some of their positions to meet the minimum margin requirement. The broker does this to make sure the trader has sufficient funds in their account to cover potential losses.
Used margin: When an investor enters into trades, some of their account balance is held by the broker as collateral in case it needs to be used to cover losses. That amount will only be available for the trader to use after they close out some of their positions.
Usable margin: This is the money in one’s account that is currently available to put into new trades.
Open position: When a trader is currently holding an asset they are in an open position. For instance, if a trader owns 100 shares of XYZ stock, they have an open position on the stock until they sell it.
Close position: The total value of an investment at the time the trader closes it out.
Stop-loss: Traders can set a price at which their asset will automatically be sold in order to prevent further losses if its value is decreasing. This is very useful if a trader wants to hold positions overnight or if a stock is very volatile.
Tips for Helping to Manage the Risks of Leveraged Trading
Experience and skill can help you manage the risk factors inherent in leveraged trades, and a couple of basic protective strategies may help.
Hedge Your Bets
It might be possible to hedge against potential losses by taking an offsetting position to the leverage trade.
Limit Potential Loss of Capital
One rule of thumb suggests that traders limit their loss of capital to no more than 3% of the actual cash portion of the trade. While it’s difficult to know the exact risk level involved in a particular trade, it’s wise to observe certain limits to protect from loss.
Decide Whether Leverage Trading Is Right for You
Although there is potential for significant earnings using leverage trading, there is no guarantee of any earnings, and there is also potential for significant loss. For this reason leverage trading is often said to be best left to experienced traders.
If an investor wants to try leverage trading it’s important for them to assess their financial situation, figure out how much they’re willing to risk, and conduct detailed analysis of the securities they are looking to trade.
Setting up a stop-loss order may help decrease the risk of losses, and traders can also set up a take-profit order to automatically take profits on a position when it reaches a certain amount.
The Takeaway
Leveraged trading is a popular strategy for investors looking to increase their potential profits. By using borrowed funds it’s possible to take much bigger positions, and possibly see bigger wins. But using leverage, or trading on margin, is very risky because you can lose more than you have (the money you borrow has to be repaid in full, plus interest).
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
Get one of the most competitive margin loan rates with SoFi, 10.50%*
FAQ
How much leverage is too high?
Knowing how much you can afford to lose is an important calculation when making leveraged trades. In addition, the amount of leverage available to you will also be restricted by existing regulations or brokerage rules. And remember, if a trade goes south, your broker can liquidate existing assets to cover your losses and any margin.
What is the safest way to use leverage in trading?
Investing always involves risk, and the use of leverage is a high-risk endeavor. When using leverage it’s wise to know your limits, both financially and in terms of your skill as an investor. It’s also important to maintain a clear understanding of the regulations around the use of margin.
Can you lose more than you invest with leverage?
Yes. The biggest risk with using leverage is that you can lose more than the total amount of your initial investment.
Why is leverage not recommended for beginners?
All forms of leverage are complex and highly regulated, and demand a certain level of sophistication. For the most part, only experienced investors should use leverage.
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