With leverage, you can get a much larger exposure to the market than the amount you deposited to open the trade. Leveraged products, like CFDs, magnify your potential profits and losses.
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Leverage is a key feature of CFD trading, and can be a powerful tool for a trader. You can use it to take advantage of comparatively small price movements, ‘gear’ your portfolio for greater exposure, or to make your capital go further. Here’s a guide to making the most out of leverage – including how it works, when it’s used, and how to keep your risk in check.
Leverage works by using a deposit, known as margin, to provide you with increased exposure to an underlying asset. Essentially, you’re putting down a fraction of the full value of your trade – and your provider is loaning you the rest. Your total exposure compared to your margin is known as the leverage ratio.
With unleveraged products, you will need to commit the full value of your position upfront. For example, let’s say you want to buy 10 shares of a company at a share price of 100p each. To open a conventional unleveraged trade, you’d be required to pay this full value upfront (£1000).
This means more initial capital outlay but also caps your risk more than leveraged trading, as the risk of loss with unleveraged trading is equal to the amount paid to open the position. So, in our example, the potential for loss is also limited to the £1000 you paid for the position.
If the company’s share price goes up by 20p, your 1000 shares are now worth 120p each. If you close your position, then you’d have made a £200 profit from your original £1000. If the market had gone the other way and shares of the company had fallen by 20p, you would have lost £200, or a fifth of what you paid for the shares.
Or you could have opened your trade with a leveraged provider, who might have a margin requirement of 10% on the same shares.
Here, you’d only have to pay 10% of your £1000 exposure, or £100, to open the position. If the company’s share price rises to 120p, you’d still make the same profit of £200, but at a considerably reduced cost.
If the shares had fallen by 20p then you would have lost £200, which is twice your initial deposit.
It's important to note that while leverage can amplify your profits, it'll also amplify your losses, so it's vital to take steps to manage your risk.
The majority of leveraged trading uses derivative products, meaning you trade an instrument that takes its value from the price of the underlying asset, rather than owning the asset itself.
Our main leveraged product is:
An agreement with a provider (like us) to exchange the difference in price of a particular financial product between the time the position is opened and when it is closed.
Some of the markets you can trade using leverage are:
When researching leveraged trading providers, you might come across higher leverage ratios – but be aware, using excessive leverage can have a negative impact on your positions.
Provided you understand how leveraged trading works, it can be an extremely powerful trading tool. Here are just a few of the benefits:
Though CFDs and other leveraged products provide traders with a range of benefits, it is important to consider the potential downside of using such products as well. Here are a few key things to consider:
Leveraged trading can be risky as losses may exceed your initial outlay, but there are numerous risk-management tools that can be used to reduce your potential loss, including:
Attaching a stop to your position can restrict your losses if a price moves against you. However, markets move quickly and certain conditions may result in your stop not being triggered at the price you’ve set.
These work in the same way as basic stops, but will always be filled at exactly the level you’ve set, even if gapping or slippage occurs. If your stop is triggered, there will be a small premium to pay in addition to normal transaction fees.
Using stops is a popular way to reduce the risk of leverage, but there are numerous other tools available – including price alerts and limit orders.
Leverage ratio is a measurement of your trade’s total exposure compared to its margin requirement. Your leverage ratio will vary, depending on the market you are trading, who you are trading it with, and the size of your position.
Using the example from earlier, a 10% margin would provide the same exposure as a £1000 investment with just £100 margin. This gives a leverage ratio of 10:1.
Often the more volatile or less liquid an underlying market, the lower the leverage on offer in order to protect your position from rapid price movements. On the other hand, extremely liquid markets, such as forex, can have particularly high leverage ratios.
Here’s how different degrees of leverage affect your exposure (and thus profit potential and maximum loss) for an initial investment of £1000:
Unleveraged trading | Leveraged trading | ||||
1:1 | 20:1 | 50:1 | 100:1 | 200:1 | |
Outlay | £1000 | £1000 | £1000 | £1000 | £1000 |
Exposure | £1000 | £20,000 | £50,000 | £100,000 | £200,000 |
Unleveraged trading | |
Ratio | 1:1 |
Outlay | £1000 |
Exposure | £1000 |
Leveraged trading | ||||
Ratio | 20:1 | 50:1 | 100:1 | 200:1 |
Outlay | £1000 | £1000 | £1000 | £1000 |
Exposure | £20,000 | £50,000 | £100,000 | £200,000 |
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