Leverage in CFD Trading: How This Affects You Trading Results & What About Margin?

Leverage is one of the several reasons why CFDs are traded by traders who have previously traded shares.

Typically the margin needed with many CFD brokers is 5-10%.

However different CFD brokers will give different amounts of leverage. And different CFDs will requrie different amounts of margin ranging from 5-10% to 80% or more.

So what does for example 10% leverage mean?

It means that with a $10 000 float, positions totalling $100 to 200 000 is possible if full leverage is used, in comparison to stocks and shares where there is usually no leverage, or with a margin loan there may be around 50% leverage.

In contrast, forex trading offers leverage at 100 to 1.

But this does not mean that you should use all the available leverage as the more leverage is used, the more risk there is in trading. The risk comes from 2 sources.

1) The risk of margin calls: If you have a margin call and cannot put more funds inm then you may be stopped out of your positions by the broker. Typically the trade has gone against you and hence a margin call, and when stopped out in this situation when the trade is at the moment against you means a loss on all these positions.

2) The results of your system are magnified. While gains during profitable trades are bigger, so are the losses when trades go against you. If they are too large, and especially if you have inaedquate risk management skills and inappropriate trade sizes, you could lose more than your cash float.

Leverage also means that it’s important to have a profitable trading system, because this is what you’re magnifying.

The worst case scenario with leverage is that you can lose more than your original cash float. This will be even more likely if for example there is a lack of money management rules in trading or you’re not using stop losses, or due to events such as stock falls to zero or to almost zero, or a drastic change in stock price due to a takeover or other event.

The use of leverage must be used carefully and many wise trades only use a little or a modest amount of available leverage (and not all the leverage), that is all dependent on their individual situation.

Why Some Trade CFDs Without Leverage Rather Than Shares? How Much Of Your Margin Should You Use?

However some traders choose to trade CFDs rather than shares, but don’t use the leverage available. They open a trading account and never go above for example, a 1 to 1 or similar low use of leverage.

So why do traders use CFDs instead of stocks in this case?

Well, some traders for example want to go short on shares, but this may be over $100 in commission one way with a traditional full service broker. With a CFD provider, the cost may be say 0.1-0.2% of trade size, which for a $10 000 trade is only $10-20 one way. Also interest is paid on short positions and this will reduce the costs of trading CFDs even further and in some cases completely offset the brokerage costs.

The other main advantage is that there are many more shortable stocks with a CFD provider than a stock broker. So if there’s a stock you want to short but can’t do so with the traditional stock exchange, then cfds will allow you to do so.

The other advantage in not using all your leverage is that there is less risk of margin calls. This is particularly so in mean reversion systems, where the prices may dip, and in a severe market dip, all your positions may dip quite low, before the rise again, or the reversion to mean.

As mentioned, if you are close to or are at full margin, and if you can't meet your margin call, then you may be stopped out of your pisitons by your broker for a loss and will not be in the positions to ride it up. If you are only using some of the margin, then you have more room to move before getting stopped out. This assumes of course that you have a good system that is profitable.

The amount that is invested into the market is the number of trades at a time, multiplied by the trade size (assuming a fixed trade size).

Remember that even though that for example 10% margin is allowed or 10 to 1 leverage, it doesn't mean that you have to use all this leverage.

So leverage should be used wisely in CFD trading, and use it according to your trading goals and overall trading plan.