WS - ALERTS.COM
WS - ALERTS.COM
Understanding CFD Leverage is Vital to Success
CFD leverage is the main reason traders get so excited about trading CFDs. CFD leverage allows you to use your current cash and trade on margin, enabling you to gain exposure to more positions than you would otherwise and increase your Return on Investment (ROI).
Just think of your leverage like buying a home. Usually you would place a 10% deposit in order to secure the full purchase price of the home. For example on a $300,000 home you may need to provide a $30,000 deposit or 10% in order to secure it. From here you will make payments until the house is paid off.
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 and in effect the CFD broker is ‘lending’ you the total amount.
If your house were to rise 10% to $330,000 then you would be sitting on an open profit of $30,000. When we consider your ROI (Return On Investment) you actually made $30,000 gain with an initial investment of $30,000. This equates to 100 percent return cash-on-cash. That is how we calculate our return on investment when Trading CFDs as well.
So that’s why there’s so much hype around CFDs!
Essentially CFDs have enabled traders to multiply their trading profits and in some cases multiply their trading losses. When Trading CFDs you must be careful not to over leverage as losses are magnified as well. Some people would refer to CFDs as a double edged sword in that regard.
Getting your head around CFD leverage is paramount
What you must realize is that You the Trader control the amount of leverage that you have 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.
Cash | Leverage | Total Exposure | Level of Experience |
|---|---|---|---|
| $10,000 | 1 | $10,000 | Inexperienced |
| $10,000 | 2-3 | $20,000 – $30,000 | Traded shares |
| $10,000 | 5 | $50,000 | Experienced Trader |
| $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 the trader control the amount of LEVERAGE used in your trading account. What this means is that the total exposure you have relative to your account size is up to you.
People who trade at more than 10 times leverage are really 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 10 times leverage is suicide for your trading account.
So how can I be safe when using my CFD Leverage?
The smartest way to get started is to trade very small and ensure your leverage does not exceed 3 times your account size. 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. That means if you have $10,000 in cash then don’t take positions that exceed more than $10,000. This means you are not utilizing 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
Initially trading CFDs is new to everyone and using very small amounts of CFD leverage is critical to your long term success. Once you have your trading system and methodologies working you can always increase your leverage as your money management and success allows.
Managing the upside and Downside
CFD leverage is very exiting when used correctly. Let’s have a look at some rates of return for simple trading systems that use leverage. What is important to note is that returns 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 are the exact 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%
CHART 1…
2nd Chart shows 7 times Leverage.
Return: 98.19% after 50 trades
Equity Low point: -25.83%
CHART 2…
3rd Chart shows 30 times Leverage – Bordering on gambling
Return: 420.81% after 50 trades
Equity Low point: -110.70% – Lost all your money!
CHART 3…
Steps to bankruptcy – Way too much leverage
You can see in the 3rd chart that despite the fact we are using a winning trading system we could in fact lose all our money if the CFD leverage we use 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. See another CFD examples here.
Key Points