Financial leverage is a mechanism with which you can trade using lower capital than is required for traditional investments. This is a typical feature of CFDs, which therefore offer you the opion of trading on financial markets with smaller capital than required on the traditional market.
In CFD online trading, leverage works just like a lever does in physics, allowing you to lift (or press etc.) bodies with less effort than the weight or strength required without a lever. In this figure, let’s see what happens with leverage of 1:20.
As you can see, if you want to trade on 20 shares with a total value of 100 euro, the amount required to trade with CFDs, thanks to leverage, will only consist of 5 euro.
In this same way, instead of investing 1000 euro, with a lever of 1:20 you can open a trading position with just 50 euro.
Stock market financial leverage
What we have just seen is an example of leverage in equity markets. Shares are among the most appreciated instruments by those who trade with CFDs, as CFD brokers generally allow trading on the most important stocks.
Furthermore, some brokers, like 24option, have thousands of shares to trade available on their platform, originating from many international markets. Brokers like 24option, on the other hand, focus on the most important equity securities, which are easier to follow, due to the voluminous financial news dedicated to them.
Forex financial lever
Another very interesting market for leverage is the Forex. The Forex, or currency market, in fact, generally has the highest leverage compared to other types of markets.
With the entry into law of ESMA in 2018, leverage on Forex trading for basic customers is 1:30, which compared to the 1:2 on Bitcoin is definitely much higher.
For clients with a professional account, however, leverage is generally much higher and on average brokers offer leverage ranging from 1:300 to 1:400.
What happens when using leverage?
We have already said that with leverage the result is that only a small part is invested with respect to the capital on which it is negotiated.
This concept must be clarified. For example, if I want to trade on €10,000 on the Forex market, with a leverage of 1:30 instead of investing €10,000, I can invest only €330.
As you can well understand, it’s one thing to invest €10,000, and another to invest €330. For those who don’t have access o large amounts of capital, it is definitely the more feasible option.
The capital that is actually required for the trade is called a “margin”. In the example above, €330 will be the required margin. Of this required margin, a part will be frozen for the duration of the open position as a guarantee to protect the broker’s interests.
We will look at margins in greater detail in the lesson dedicated to margins in CFDs.
Go to lesson 3 – The CFD trading platform