Leverage: trading with leverage explained

When you choose to trade CFDs, you’ll soon be confronted with the term ‘leverage’. Thanks to leverage, you can trade with a small amount of money and still profit greatly on tiny fluctuations in the market. Trading using huge leverage does come with a certain amount of risk.

This article forms part of a short course on trading CFDs.

Leverage and the multiplier effect

leverageWith CFD trading, you can use leverage whenever you want. Leverage is always displayed as a ratio, for example 1:50. When the leverage is 1:50, this means that you can trade with 50,000 pounds by investing only 1,000 pounds. The result is that you can add many more stocks to your portfolio.

How does leverage work?

Leverage can be compared to a loan. The broker finances a large portion of the purchasing price and the difference between the opening and closing price will eventually be settled in your account balance. You are never the owner of a stock; the broker will take care of both buying and selling. When trading CFDs, you don’t have any other responsibilities because you’re never the physical owner of a stock.

Benefits of high leverage

A tremendous benefit of high leverage is the fact that you can make a lot of money by only investing a little. When the price of a stock goes up by one pound and you’re using a leverage of 1:50, you make 50 pounds. When the price goes down by one pound, you’ll lose 50 pounds. These profits and losses will be settled in your account. The difference between the opening price and the closing price will determine your success with a trade.

Be careful when using leverage!

You won’t be the first person to open up on a 1:400 leverage position. With higher leverage comes greater risk. In this example, every pound that you lose will be lost 400 times faster. Leverage can work both ways and it’s important that you use this investment option responsibly. Beginners should not start out using a high leverage and they should only start using this incredibly useful instrument when they know what they’re doing. Once you know how to make money in trading, you can use leverage to massively increase your earnings. 

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