CFD leverage and margins explained

• Leverage allows traders to open larger CFD positions with a smaller amount of capital by increasing their market exposure relative to their initial investment.
• Margin is the deposit required to open a leveraged position and is typically expressed as a percentage of the total trade value.
• While leverage can increase potential returns compared with unleveraged trades, it can also magnify losses by the same proportion.
• Risk management techniques such as using stop-loss orders, starting with lower leverage, and limiting position sizes could help reduce exposure to potential losses.

A CFD, or ‘contract for difference’, is a leveraged financial derivative product. CFDs allow traders to speculate on price movements of various instruments, but they differ from traditional investing because traders never take full ownership of the underlying asset.

A CFD is essentially a contract between a trader and a CFD broker to settle the difference in the price of an underlying asset between the time a position is opened and when it is closed.

For example, if a trader expects a company’s shares to rise, they could open a long (buy) position of 10 CFDs at $100 each, spending a total of $1,000. Each of these CFDs would be worth $1 in price movement, so if shares reach $110 by the time they close the position, the trader would make a $100 profit. The same is true for when the market doesn't move in their predicted direction, in which case, they would've made a $100 loss.

Learn more in our guide on what CFD trading is and how it works.

We’ve described CFDs as leveraged financial derivative products, but what does ‘leverage’ mean in trading?

Simply put, leverage allows traders to trade on a financial market without paying the full capital required to open the trade. This means that traders can control large positions in the market with much less capital than would typically be needed.

For example, let’s say a trader is looking to go long by buying 10 shares in a company, with each share valued at $1,000. Without leverage, this position would cost $10,000.

Leverage is expressed in a ratio, showing how much more buying power your capital could have compared to its original value. A leverage of 10:1, with no other charges, would let you open a position 10x larger than what your capital would originally be worth.

In this case, if the trader is looking to go long and buy the same 10 shares with a 10:1 leverage, they would only need $1,000. You can calculate the price needed to take a leveraged position by looking at the total unleveraged cost (e.g. $10,000) and dividing by the amount of leverage your capital has ($10,000 ÷ 10 = $1,000).

Margin is the amount of capital required to open a leveraged position. You can think of it like a deposit, where a certain amount of capital is required as a safety net to show that you’ll be able to complete your trade.

The margin required for leveraged trading is expressed as a percentage of the trade’s value, known as a deposit factor (or margin factor). For example, in a trade with a 10:1 leverage ratio, the margin factor is 1/10, or 10%. If you’re looking to make this leveraged trade, you’ll need 10% of the total investment value before you could open a position.

The deposit factor of a CFD trade is influenced by changes in market prices, position sizes, stop losses, and more. Leverage and margin also share a direct inverse relationship, meaning as one increases, the other falls by the same amount.

Let’s take a look at how to calculate a leveraged CFD trade using an example, and compare it to an unleveraged trade.

In this scenario, one investor buys $5,000 in Tesla shares in an unleveraged trade. Another investor makes a trade of the same value but uses a leveraged CFD.

The first trader pays the full value of the shares upfront, but the second one chooses to make a 5:1 leveraged trade. This means their margin factor is 1/5 of the total shares, or 20%. 20% of $5,000 is $1,000, so the margin in this scenario is $1,000.

If Tesla shares increase in value by $500, then the two traders would have differing profits.

The unleveraged trader’s value increases from $5,000 to $5,500. This means their original investment has returned 10%, as $500 is 10% of their initial $5,000 trade.

The leveraged CFD trader, however, only deposited $1,000 when opening their position. While they received the same $500 profit as the first trader, the change in value from their initial investment is much greater, as they deposited a smaller amount for the same return. In this case, a $500 increase in value on their $1,000 deposit means their investment has returned a 50% profit.

If the shares decrease in value by $500 instead, the leveraged CFD trader would experience a much larger loss relative to their initial deposit. While the loss is the same in monetary terms as the first trader, the change in value compared to the $1,000 margin is significantly greater. In this case, a $500 decrease in value on their $1,000 deposit means their investment has returned a 50% loss.

One thing you might want to keep in mind when trading CFDs with leverage is that the same applies to losses. While profits could be much higher when trading with leverage, an unsuccessful trade could also have its results magnified, so it’s important to be aware of the risks surrounding leveraged trading.

As with all forms of trading, there’s no guarantee of profits when trading leveraged CFDs, and losses could be magnified by the same order as potential earnings. This is why it’s important to have a risk management plan in place when trading on any financial market. Here are some ground rules you could apply to your leveraged CFD trading to minimise the impact of your losses:

Using stop-loss orders

A stop-loss order automatically closes your position if it reaches a certain price. When used correctly, this could prevent your capital from spiralling in value, capping your losses at a specific point rather than allowing them to snowball into even bigger drops in value.

Starting with low leverage

While it may be tempting to use leverage to its full potential as soon as you receive the option, a poor trading decision could hugely impact your capital. If you’re new to leveraged trades, you might want to try starting with low-margin options that reflect your capital more accurately, before building up to larger positions once you feel more confident. You could also open a demo account to practice trading without risking the loss of real money.

Limiting your position size

Many traders might choose to limit the amount of positions they open to only a certain percentage of their total capital. For example, a trader may set themselves a 1% rule, where each trade is worth only 1% of their total account value. In this case, if the total value of their account is $30,000, they would limit themselves to a maximum of $300 in trades to mitigate potential losses.

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