CFD leverage is one of the most important concepts to understand before trading contracts for difference (CFDs). With leverage, you can control a position larger than the amount of money available in your trading account.
However, using CFD leverage also increases your risk exposure. Before using leverage, you must know how it affects position size, margin requirements, profits, losses, and overall risk when opening a position.
Think of leverage as a tool that allows you to open and manage a position with a market value greater than the amount of capital you have available in your account. Instead of providing the full value of a trade, you provide a percentage of its total value as margin. The broker provides the remaining exposure required to open the position.
For instance, if your broker offers 10:1 leverage, this means that using $1, you can open a trade worth $10. If you have $100 available in your account and you use the 10:1 CFD leverage, you can control a position worth $1,000.
However, leverage does not mean that you only bear the risk of the amount deposited as margin. Your profit or loss is calculated based on the full position size, which is why leverage magnifies both gains and losses.
The easiest way to understand how to account for leverage on CFDs is to look at the relationship between position size, leverage, and margin.
§ How to Calculate Margin for CFDs
Let’s say you want to open a CFD trade worth $10,000 on this website here. Without leverage, you must have at least $10,000 in your trading account. However, this is a large sum, and not many traders have this amount just lying in their trading account.
With 10:1 leverage, the required margin would be approximately $10,000 ÷ 10 = $1,000. Therefore, if you have $2,000 in your account, you can use $1,000 as margin and open a $10,000 position.
§ Calculating Profit or Loss
If the CFD asset you are trading rises by 2%, the position would gain approximately $200. However, if the price falls and goes against your speculation, you would lose $200 before trading costs are factored in.
One thing to notice is that the 2% price movement applies to the $10,000 trade, not just the $1,000 margin. This is what makes CFD leverage both a powerful and dangerous tool. In trading lingo, some traders refer to leverage as a double-edged sword.
Using higher leverage on CFDs is risky. Because CFDs provide exposure to the full position value, even the smallest market movements can result in substantial losses. Taking a high-risk approach using high leverage can lead to margin calls.
Also worth noting, leverage does not eliminate trading costs. Depending on the CFD and your broker, leverage will have an impact on the spread, commission, and swap fee.
Lastly, a highly leveraged CFD position can become difficult to manage during periods of high volatility.
CFD leverage can be a useful trading tool. However, it can also significantly increase risk. Before using leverage, understand that high leverage does not necessarily mean better trading opportunities.