Is lending investment in stocks really worth it? Four major pitfalls behind leverage you need to recognize

Why Leverage Investing Has Become a Double-Edged Sword for Investors

There is a saying in the stock market: “Make money with other people’s money.” Borrowing money to buy stocks, known as leverage investing, can indeed amplify returns quickly when the market is favorable. However, many investors only see the upside and overlook the hidden risks behind it.

The original intentions for using leverage vary widely. Some do it to seize fleeting investment opportunities, some want to free up part of their capital for diversified allocation, and others use loans for hedging operations (such as short selling) to reduce portfolio risk. But the fact is, leverage amplifies not only gains but also losses.

When the cost of borrowed funds is lower than the investment return, leverage is indeed a powerful tool. But if the market moves against you, you not only face losses from declining stocks but also have to pay additional interest costs. This double blow can quickly swallow the investor’s principal.

Four Ways to Invest with Borrowed Funds: Which One Is Right for You?

Method 1: Margin Trading — Professional Leverage Tools Provided by Brokers

Borrowing money (margin financing) or short selling stocks (securities lending) from brokers are the most common forms of loan-based investing.

Margin Buying is attractive because investors don’t need to wait for capital accumulation and can act immediately on good opportunities. The annual interest rate is about 5%-8%, relatively low among borrowing options. However, account opening requirements are not trivial—usually needing to be open for at least 6 months, with assets over 500,000 yuan, and some trading experience.

Short Selling suits investors bearish on the market, but the risk is unlimited. Stock prices have no ceiling on upside, and theoretically, losses can be infinite. That’s why securities lending is often called “the riskiest leverage game.”

Method 2: Credit Loans — Lower Bank Thresholds but Higher Costs

Applying for a credit loan from a bank for investment purposes requires no collateral, only a good credit record and stable income. The annual interest rate typically ranges from 8%-15%, which is higher than margin trading and securities lending.

The trap here is that if the investment underperforms, repayment pressure immediately arises. If returns cannot cover the 8%-15% interest costs, it falls into a vicious cycle of “investing to repay debt.”

Method 3: Stock Pledge — A Balanced Option for Long-Term Holders

Pledging high-quality stocks you hold to brokers or banks to obtain funds for other investments. The annual interest rate is about 6%-10%, between margin trading and credit loans.

Suitable for investors who already hold certain quality stocks and have no short-term plans to sell. The risk is that if the pledged stock price plummets, you may face margin calls or forced liquidation.

Method 4: Margin Trading — High-Risk Path of Derivative Leverage

Investors only need to pay a portion of the contract value as margin to trade futures, CFDs, and other derivatives. Some trading platforms directly offer leverage tools without complex application procedures.

This method is the most flexible, supporting both long and short positions, but also the most dangerous. In extreme market conditions, investors may face margin calls or liquidation, with principal evaporating instantly. Suitable for professional investors and those with high risk tolerance.

Cost Comparison of the Four Borrowing Methods

Five Key Tips for Risk Control in Loan-Based Investing

Step 1: Calculate the interest costs clearly

This is the most overlooked aspect by many investors. If the borrowing interest rate is 8%, your investment return must exceed 8% to be profitable. In other words, you bear all the risks and only earn the part above interest.

Many investors get caught up in rising markets, borrowing money to chase gains, without considering the interest costs. When the market reverses, they realize that even if stocks don’t lose value, the interest costs have already eroded most of the gains.

Step 2: Never let leverage exceed 50%

Debt ratio (leverage ratio) is a core risk control indicator. Industry consensus suggests not exceeding 50%, meaning borrowing should not surpass 50% of your own capital.

Even if you have strong risk tolerance, you shouldn’t cross this red line. Because once exceeded, losses accelerate exponentially, ultimately leading to liquidation.

Step 3: Reserve emergency funds for unexpected situations

Managing cash flow becomes critical after borrowing for investment. Investors must reserve 3-6 months of emergency funds to handle unforeseen events like unemployment or illness. Failure to repay on time can result in penalties and damage your credit record.

Step 4: Set stop-loss points and strictly follow discipline

Stop-loss is the lifeline for leveraged investors. Before each purchase, set a stop-loss point. When the stock price drops to that level, sell immediately—don’t hold out hope. Emotional trading is often the main cause of losses in leverage investing.

Step 5: Develop a plan to overcome emotional trading

Borrowing money adds psychological pressure far greater than ordinary investing. Investors tend to fall into traps of chasing gains and selling at losses, overtrading. The solution is simple: write down a clear plan for each investment, including entry point, stop-loss, and target price, then execute mechanically without emotional interference.

Conclusion: Borrowed Funds Require Greater Discipline

Leverage investing is not impossible to use, but it is much more difficult than ordinary investing. Successful loan investors are often not smarter but more disciplined and calm.

Before using any form of leverage, investors must soberly recognize: while amplifying gains, they are also magnifying losses. True investment masters are not those who make big money with leverage, but those who know when not to use leverage.