Trading CFDs has been known globally especially due to the availability of retail Forex investors and also the utilization of leverage. However, combined with its vast popularity is a misunderstanding that seems to be going around for decades. The nature of CFD and its effects on the trader’s account is mostly misunderstood. People are particularly concerned with the negative effects that leverage can do on their accounts. They fear that the use of leverage can speed up their profit but will also magnify losses. For you to be able to eliminate those fears, a better understanding of this trading method is highly recommended.

Defining leverage

Unlike when trading stocks, CFD trading allows its traders to borrow money to be able to buy or sell a larger amount more than the ones they have invested in their accounts. The money you borrowed is the leverage used. Most of the time, a trading account has a margin of 50:1, 100:1, or even as high as 400:1. If the trader has a margin of 200:1, this means that the trader needs to have at least $10 to be able to trade $2000.

At certain times, the margin requirement that is used in trading differs from the one which was initially introduced. The initial margin is known as the maximum margin level that the trader can use in a single trade but the real margin goes way lower than that. To better understand the margin requirement which was specified above, it is important to elaborate that it is a per trade requirement. As for the leverage, it is known as the amount of money that the trader borrowed to be able to open a larger trading position.


For instance, the trader was able to buy 10,000 euros but paid it in USD. In this case, the $75 of the total equity will be utilized in the EUR/USD trade. If the trader’s account consists of $5000, this means that the trader only engaged 75/5000 or 1.5% of its total trading account. The remaining 98.5% can be used for other purposes. The leverage used in this example is 2:1. It is about 100 times lower compared to the leverage of 200:1 given to the trader.

After some time and the trader decides to buy again another 10,000 euros, then it will take $75 out of the equity. The trader now utilized 3% of her entire trading account but maintained a safety net amounting to 97%.

More Examples

The problem with this example mentioned above is the movement of a single pip which is about $100. Meaning to say, the account can only withstand 50 pips created under negative movement. But this huge movement is always possible when trading CFDs. Without a doubt, the market is full of uncertainties that you can never prepare yourself for. One moment your trading is good but the next thing you knew, your trading plan is failing you. Therefore, it is important to employ a good risk management strategy to avoid such incidents and properly use leverage in boosting the potential profit of the trader.


Spread the love

By lily

Leave a Reply

Your email address will not be published. Required fields are marked *