With the financial leverage in CFD trading we can trade with a small capital compared to traditional investment.
In CFD trading, leverage works exactly like leverage in physics, allowing you to lift (or push, etc.) bodies with less effort than the weight or force required without the lever.
Let’s look at what happens with 1:20 leverage: If you want to trade 20 shares of the total value of $100, the amount required to trade CFDs, with the leverage, will be only $5. Similarly, instead of investing $1,000, with 1:20 leverage you can open a trading position with $50.
Financial leverage in the stock market
What we have just seen is an example of leverage in the stock market. Stocks are among the most popular tools for CFD traders, as CFD brokers usually allow you to trade the most important stocks.
In addition, some brokers, such as Plus500, have thousands of shares on their trading platform from all over the world.
Forex Financial Leverage
Another very interesting market in terms of leverage is Forex. The foreign exchange market or Forex, in fact, generally has the highest leverage compared to other markets.
With ESMA coming into effect in 2018, Forex leverage for basic clients is 1:30, which compared to Bitcoin’s 1:2 is definitely much higher.
On the other hand, for professional clients, the leverage is generally much higher and, on average, brokers have a leverage that varies from 1:300 to 1:400.
What happens when we use leverage?
We have already said that with leverage the result is that only a small part is invested in relation to the capital with which it is quoted.
This concept must be clear. For example, if I want to trade for $10,000 in the Forex market, with a leverage of 1:30 instead of investing $10,000, I will be able to invest “only” $330.
As you can understand, it is one thing to invest $10,000, and another to invest $330. For those who do not have high capital, it is much more convenient.
The capital that is actually required for the investment is called “margin”. In the example just given, therefore, $330 will be the required margin. Of this required margin, a portion will be frozen for the duration of the position opening as collateral to protect the broker. We will look at margin in more detail in the CFD margin lesson.
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