For trader’s leverage can be a boon as well as a curse in equal measure. It is capable of making or breaking a successful trading career. Traders, who have turned millionaires trading, got there because of leverage.
Without this valuable tool they would possibly be working hard to build their trading capital and nowhere near success. Popular trading forms like CFD and spread betting depend massively on leverage. Myriads of aspiring traders get attracted, every year.
What is leverage?
Leverage is a loan provided on a given trade transaction by the broker. This offers a trader wide exposure to CFD trading markets and shares without investing 100% of total asset value. Trader can open a position of higher value than the balance in current trading account. A margin requirement is generally 5% for opening a position. The trader can earn or lose 100% with personal contribution of 5% [or agreed margin rate].
CFD leverage example
You will need $35,000 for 1,000 PLC shares priced at $35. On the other hand, to open CFD position for the same PLC share position margin requirement is 5% that means $1,750.
Standard PLC share trade with $1,750
With $1,750 you can buy 50 shares priced at $35. When price reaches $37 you wish to sell it. You get $1,850. Thus, there is a profit of $100 or 5.7%
Leverage trade with margin deposit $1,750
Buying capabilities will increase with margin requirement of $1,750. A trader can buy 1000 CFDs and open a position for entire physical asset value $35,000. If he sells it at $37 then the gains will be $2,000 or 114% [$37 x 1,000 = 37,000].
You can see the power of leverage, but you will need to keep in mind that losses also get magnified in the same way using leverage.
Warning – CFD is double edged sword
Many traders get tempted to increase their profits because they get access to more money. CFD leverage can magnify profits as well as losses. Therefore, be careful of not over leveraging because your account can get wiped away very fast.
Use CFD leverage smartly
Control leverage amount in your trading account is paramount. It means the total exposure you need to have will be proportional to your trading account size. Using more than three times leverage is suicidal. For example, if there is $10,000 deposit in your account then avoid taking positions more than $30,000.
Most traders feel that using small leverage, while trading is waste of time. Avoid getting trapped because capital preservation is crucial to stay on-board. So, start using small amount or zero leverage. For more CFD tips visit this link – https://capital.com/financial-derivatives-cfd.
What is step margin level?
CFD provider will increase margin requirement for large size trades, accordingly. Large trade size is connected with high risk level. Margin requirement set at specific levels is called ‘step margin levels’.
In ABC Company at $5 initial margin is 5%. If extra spread of $12 in same market is bought, your stake size in trade market is $17 per point.
The provider will apply initial step margin of 5% on $10 and second step margin of 10% on remaining $7. Step margins are provided only for spread bet and CFD trade markets.
What’s margin call?
Margin call occurs when your trading account balance falls below regulatory needs governing margin debt owing to asset price fluctuations or modifications by regulators. According to current rules minimum margin borrower need to have is minimum 50% equity while purchasing and minimum 25% at all times. However, margin maintenance needs depend on the brokerage firm’s margin policy. It can be higher than minimum regulatory rules.
Therefore, when a situation occurs, where your account does not have needed equity to debt ratio, which meets regulatory guidelines or brokerage firm’s margin maintenance needs then a margin call gets issued. The broker will demand instant rectification by depositing extra fund or liquidate your holdings. Therefore, it is recommended to monitor your margin level regularly.