CFD trading is a new exciting opportunity of investing in the financial markets and CFD leverage is one of the key reasons of popularizing the trading of CFDs. CFD leverage helps a trader to increase his Return on Investment (ROI), as one can trade on margin using the current cash.
To understand it better, let’s consider you are buying a home. The price of the home is $100,000 and by depositing 10% of the full purchase price, you can secure the house for yourself. Afterwards you can make payments in full until the full price is paid off.
In the same manner in the CFD trading, if you want to buy stock of $10,000 in any financial market, you may need to invest only 10% or $1000 to purchase the total stock of $10,000, if the CFD broker allows you the CFD leverage. The CFD leverage means that your CFD broker is lending you the total purchase price of the stock and you invest only 10% of the value.
Now, suppose the value of your purchased stock rises by 10% to $11,000. So, you make a profit of $1000, by investing your own $1000. This way you get a 100 percent Return on Investment, and this is the advantage of CFD leverage that makes CFD trading more lucrative.
Control on CFD leverage
Experienced CFD traders maintain that CFDs often function as a double-edged sword. While the leverage helps you multiply your trading profits, it can multiply trading losses as well in many cases. So, one must not over leverage, as it may magnify losses as well.
One important way to determine the CFD leverage is by using the following formula:
CFD leverage = Total exposure / Account size
So, if you have $10,000 in total positions and your account size is of $1000, your ideal leverage could be $10,000 / $1000 or 10 times.
However, the ideal CFD leverage limit depends on the experience of the traders. A newbie trader should not opt for more than 2 or 3 times leverage while a more experienced trader may go above 5 times leverage. The leverage of ten times or above is often considered as a gambling and is very risky indeed.
The best way is to start trading with a small amount and not to use a leverage of more than 3 times. If you are new in CFD trading and you are willing to learn more about it, it is better that you start with zero CFD leverage.