What is Leverage in CFDs

A contract for difference (CFD) is a financial derivative instrument that allows you to trade a large amount of value of a commodity, such as stocks, indices, forex, commodities, etc., with a small amount of capital. This method of trading is called leveraged trading, because you only need to pay a certain percentage of margin to control a larger contract value. In this article, I will introduce what leverage is in CFDs, what are its benefits and risks, and how to use it.

Definition and Calculation

Leverage is the ability to control a large amount of assets with a small amount of capital. In CFD trading, you only need to pay a certain percentage of margin to buy or sell a certain amount of commodities. This percentage is called the margin ratio, which determines your leverage ratio. For example, if you use 1000 yuan as margin, with a 10% margin ratio to trade 10,000 yuan worth of stock CFDs, then your leverage ratio is 10 times (10,000/1000). This means that you only need to pay 10% of the commodity value to control 100% of the commodity value.

The leverage ratio can be calculated by the following formula:

Leverage Ratio = Contract Value / Margin

Where contract value is the number of commodities you trade multiplied by the current market price. Margin is the amount of capital you need to pay to open or maintain a trade. Margin ratio is the percentage of margin to contract value.

Pros and Cons 

Leveraged trading has two sides, both benefits and risks. The benefit is that you can magnify your profit potential, because your returns are based on the contract value rather than the margin. The risk is that you can also magnify your loss risk, because your losses are also based on the contract value rather than the margin.

For example, if you use 1000 yuan as margin, and trade 10,000 yuan of stock CFDs with a 10% margin ratio, if the stock price rises by 5%, then your profit is 500 yuan, equivalent to a 50% return rate. If you buy the stock directly, you need to pay 10,000 yuan, and the profit is only 500 yuan, equivalent to a 5% return rate.