There are numerous advantages to trading contracts for difference (CFDs), which are quick, accessible and enable investors to profit even in a depreciating market.
However, there are also various challenges and misconceptions associated with CFD trading, with some estimates suggesting that between 74% and 89% of retail investor accounts lose money through this vehicle.
This may be caused by a lack of understanding, particularly when it comes to margin and leverage and the relationship between these two entities. In this post, we’ll explore the concepts of margin and leverage further, whilst asking how they contribute to your CFD trading experience.
Understanding Margin – How Does this Work in Trading?
When trading derivatives and CFDs, margin refers to the amount of money that you need to deposit with a broker in order to open and maintain a position.
So, when looking to execute an order and engage in CFD trading, you’ll need to ensure that you have enough net equity in your account to pay the margin requirement and any associated commission.
It’s interesting to note that margin requirements vary across different markets and asset classes, whilst the size of your deposit is also influenced by the size of the position that you’re looking to open.
To calculate the required margin of a particular trade, you’ll need to multiply the notional value of your trade (stake x the price of the instrument) by the margin factor.
Exploring the Leverage Between Margin and Leverage
In the case of leverage, this work by using your margin to achieve increased exposure to an underlying asset.
More specifically, you’ll lay down a fraction of the full value of a particular trade and use this to essentially borrow the remaining capital from your online brokerage platform.
Your total exposure compared to your margin is referred to as the leverage ratio, and this will have a direct impact on your potential profit and loss once you’ve closed the position in question.
As we can see, there’s an intrinsic link between margin and leverage, and this is crucial to how CFD trading works. Through this investment vehicle, you can subsequently profit from several different markets, from forex and indices to shares and even cryptocurrencies.
The indices market is particularly popular amongst CFD traders, as indices are not physical assets and can only be traded through products that mirror the price movements of assets such as stocks and gold.
Regardless of your chosen market or asset class, however, it’s important to trade carefully when trading CFDs. After all, whilst the opportunity to generate profit is huge, you also risk losing far more than your initial deposit amount.