CFDs 101 - What is margin and leverage?
You may have heard about contracts for difference, or CFDs. That they carry additional risk but can work well for the agile, short-term trader. You know the type-fast movers, even faster thinkers. But you might not know what's involved or how they work at their core.
Let’s dive in – in the video you will gain insights on the building blocks for using CFDs to trade the world’s financial markets – respecting but harnessing the power of leverage.
As we learned in the video, CFDs are contracts that pay the difference in the price between the opening and closing of a trade. What makes CFDs unique is that the trader doesn’t own the underlying asset, instead, they use borrowed money to place the trade on that asset, believing its price will follow a certain course.
This is called leverage - it is the most prominent feature of CFDs and if you have the risk tolerance, leverage is one of the overriding attributes for trading these products.
Now, leverage carries increased risk if the trader does not account for position size but generally speaking, regardless of whether the trader is looking at equities, indices, commodities, forex, or even crypto in some parts of the world, leverage is the very thing that sees them gravitate to CFDs over other tradable instruments.
Technically speaking, leverage is a function of the margin you put down to facilitate the trade. Where margin is the amount of money that you need in your account to open or maintain a position and represents a buffer against potential loss on a trade. Trading on margin means that you can have the full market exposure by depositing only a fraction of the trade’s total value.
As we heard in the video - Deena wants to open a Buy trade with 30:1 leverage. The USD notional, or face value of this trade is $100,000. So, in this instance, the margin required is $3333.
Without leverage, Deena would have needed $100,000 to be able to open such a position.
Understanding how leverage can influence your strategy is fundamental to trading.
We can adjust the degree of leverage depending on our risk profile and volatility in the market as well as whether we use a pro or retail account. But as a general view, leverage may fit the needs of some traders. Especially for those whose strategy may require multiple positions at once or who have smaller account balances, but still want the freedom to trade the world's financial markets.
Benefits and risks of trading leverage
- Allows traders to open multiple positions – highly beneficial if running systematic strategies that may result in taking a number of trades.
- For smaller account sizes, leverage allows traders the ability to take positions they may not have been to in the futures market or direct shares.
- Having flexible leverage rates allows trades the ability to be dynamic to fluctuations in volatility and manage risk more efficiently
- Using leverage expose a trader magnified losses if the position moves against him/her
- Trading with leverage is not suitable for traders without previous exposure/experience to CFD instruments.
Learn more about trading CFDS
Here at Pepperstone, our customers love the product range along with the low cost to trade and the fact so many markets are open around the clock. Interested? Watch the more videos to learn or speak to our team about whether CFDs are right for you.