How to Use Leverage Wisely in CFD Trading
How to Use Leverage Wisely in CFD Trading
Blog Article
CFDs have become a popular method for bringing people who enjoy financial markets up close without necessarily owning the asset. Another attractive but dangerous aspect of using leverage in CFD trading, it magnifies the gains significantly when properly used and, unfortunately, becomes a source of grievous losses when misused.
Thus, the present article seeks to help beginners how to use leverage in trading responsibly to safeguard capital.
Learn more about trading basics at tradewill.com
TIP: Approach leverage with caution and respect—it can multiply your profits but also amplify your losses. Start with a thorough education before putting real money at risk.
Understanding Leverage in CFD Trading
Leverage in CFD trading can be conceived, for the simplest part of it, as controlling a position vastly bigger than what the money in your trading account will afford, using margin, which is a fraction of the total trade, to do that.
For instance, with a leverage ratio of 10:1, one can control $10,000 worth of any asset without having it on their account, but it costs them only $1,000 as initial capital. However, it also needs to be understood that profits and losses are calculated on the full position value and not on just the margin amount since capital is reduced to much lower levels than in traditional trading.
In brief, it means you borrow capital from your broker to open bigger positions. Because of that, any price changes will have a much more severe impact on your trading account, positive as well as negative.
Margin Requirements and Leverage Ratios
A trader must know margin requirements as well as the leverage ratios to use leverage effectively. Margin requirements are a percentage of the total trade value that must be deposited to open a position.
Margin requirements may differ based on:
Type of asset being traded
Volatility in the market
Policies of the broker
Regulatory requirements
TIP: Choose your stop-loss type based on market conditions and your risk tolerance. In volatile markets, paying extra for guaranteed stops may be worth the additional cost.
CFD trading has this form of a leverage ratio: the ratio between total position value and required margin. The common ratios include:
1:5 (needing the 20% margin)
1:10 (10% margin)
1:30 (needing roughly 3.33% margin)
What you deposit as margin is security against loss, which, at the end, when the position closes, is generally refunded to you unless the loss incurred goes beyond the amount of your initial deposit.
The CFD Leverage Risks and Rewards
The charm of leverage lies in its ability to create greater returns, while CFD leverage risks and rewards go hand in hand. Here is a situation:
You invest $500 as margin with a leverage of 1:5 to control $2,500 worth of shares. When the share price rises by 10%, your profit comes to $250, or $2,500 × 0.10, which means a 50% return on your $500 margin—more than five times the return without leverage.
However, if the price falls 10%, you would incur a loss of $250, or 50% of your initial margin. The loss would be magnified, which is the risk of leverage.
Furthermore, traders should be aware of margin calls. This happens when the equity in your account falls below what is required for the maintenance margin level, thereby causing your broker to call for more funds or close your positions to minimise further losses without any bad benefit.
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