Understanding CFD Leverage is Vital
CFD leverage is the main reason traders are drawn to trading CFDs.
CFD leverage allows you to use your current cash and trade on margin. Effectively, you only need a small amount of capital to control a much larger position.
Just think of your leverage like buying a home. You would place a 10% deposit to secure the full purchase price of the home.
For example, on a $500,000 home, you need a $50,000 deposit or 10% to secure it. From here you will make payments until the house is paid off.
It is a similar concept when trading CFDs
If you wanted to purchase $300,000 worth of blue chip stocks on the Australia market, you would need around 10% as margin or $30,000.
This is where CFD leverage comes in. In simple terms, your CFD broker is ‘lending’ you the total amount.
If your house were to rise 10% to $550,000, then you would be sitting on an open profit of $50,000.
When we consider your ROI (Return On Investment), you made $50,000 gain with an initial investment of $50,000.
This equates to 100 percent return cash-on-cash. That is how we calculate our return on investment when trading CFDs as well.
One of the reasons CFDs are so popular
The ability to access more funds has allowed many traders to multiply their profits. On the other side of the coin, traders using leverage have also magnified their losses.
When Trading CFDs you must be careful not to over leverage as this is the fastest way to wipe out your trading account. Some people CFDs as a double-edged sword in that regard.
Getting your head around CFD leverage is paramount
What you must realise is that You control the amount of leverage in Your account.
CFD leverage = Total exposure / Account size
Therefore if you had $100,000 in total positions with a $10,000 account size you would be trading at $100,000 / $10,000 or 10 times leverage.
Here are some guidelines when using CFD leverage.
Level of Experience
|$10,000||2-3||$20,000 – $30,000||Traded shares|
|$10,000||7-10||$70,000 – $100,000||Professional Trader|
|$10,000||10+||$100,000 +||Leverage too high. Highly skilled intraday trader with very tight stops|
I said it before, but it is worth mentioning again
You control the amount of LEVERAGE in your trading account.
What this means is the total exposure you have relative to your account size is up to you.
People who trade at more than ten times leverage are gambling their trading account.
So if you had $10,000 cash you could access up to say $100,000 or even $200,000 worth of positions. If the market moved 5% against your $200,000 in positions, then you have just wiped out your account.
So much for that round-the-world 5-star holiday.
Trading at more than ten times leverage is suicide for your trading account.
So how can I be safe when using CFD Leverage?
The smartest way to get started is to trade very small and ensure your leverage does not exceed three times your account size. If you have $10,000 cash, then make sure you don’t take positions that total more than $30,000.
If you have $10,000 cash, then make sure you don’t take positions that total more than $30,000.
In fact, you are best off starting with ZERO CFD leverage just to dip your toe in the water.
If you have $10,000 in cash, then don’t take positions that exceed more than $10,000.
Therefore you are not utilising the leveraging aspect of CFDs. However, you will get opportunities to short which you wouldn’t with a standard share trading account with no leverage.
Experience multiples your wealth
When you start trading CFDs, you must keep your leverage extremely small. Always remember, capital preservation is key.
Once you have your trading system and methodologies working, you can always increase your leverage as your money management allows.
Managing the upside and downside
CFD leverage tends to get people excited, but only when they are winning.
Let’s have a look at some rates of return for simple trading systems that use leverage. What is important to note is that profits are multiplied but so are the losses or what we refer to in trading terms as drawdown.
NOTE: Each of the following charts illustrating a positive return is the same trades, just the amount of CFD leverage used differs.
1st Chart shows ZERO Leverage.
Return: 14.03% after 50 trades
Equity Low point: -3.69%
2nd Chart shows seven times Leverage.
Return: 98.19% after 50 trades
Equity Low point: -25.83%
3rd Chart shows 30 times Leverage – Bordering on gambling
Return: 420.81% after 50 trades
Equity Low point: -110.70% – You lost all your money.
Steps to bankruptcy – Way too much leverage
You can see in the 3rd chart that despite using a positive expectancy trading system, you can lose all our money if the CFD leverage is too high.
This serves as a fantastic example of the importance of controlling your CFD leverage. It truly is the key to staying in the game longer and if done correctly, allowing you to survive the inevitable drawdowns.
- CFD leverage = Total exposure / Account size
- When starting out use no leverage up to a maximum of 3 times leverage
- Start small and build confidence in your trading system
- Make sure your CFD trading is within your means