If you’re serious about trading CFDs, you’re probably all too familiar with how leverage works and the benefits it can have on your trading success. Prolific traders across the world are using leverage to gear up their potential winnings, and to boost their incomes beyond capital restraints, maximising their trading advantage with the help of their brokers and financing partners. Indeed, high-risk investment funds are leveraging billions in principal capital to deliver a return for investors, and with careful and rigorous management of risk leverage can add significant value to your trading endeavours.
1. Increased Exposure with CFDs
Perhaps the most obvious advantage of leverage is that it allows you as a trader to increase your exposure to particular positions, both long and short, where indicators point in a particular direction. When trading CFDs for example, margin requirements are often low enough to offer gearing of as much as 20:1 – effectively allowing 20 times the earnings of a pound-for-pound, unleveraged position to deliver a higher rate of return.
This makes it possible to reap the rewards of a much larger investment, without having to stump up the capital in the first place. Of course, the money has to come from somewhere, and so leveraged positions attract financing costs and thereby become more expense with time. But by using leverage sparingly as a means of amplifying your sure-fire positions, it can be a highly effective tool for maximising your trading profits.
In practice, leverage allows you to fully capitalise on market movements in your favour. For example, Company X shows promising signs for future growth, and a trader takes a long position in CFDs worth $1,000, with a margin requirement of just $50. Assuming the value of CFDs in Company X shows a 10% rise, the gross profit (before interest and commissions) on the $50 investment would stand at $50 – a 100% return on investment.
If the trader has invested in Company X stocks without any leverage, the same rise would have generated a return of $5, or just 10% – thus, the value of leverage is evident in permitting a more efficient use of your investment capital.
2. Offset CFD Capital Losses from Other Investments
Leverage also allows investors to offset capital losses from other trading activities, and assuming an individual trading portfolio isn’t too heavily exposure to debt, a few successful leveraged positions can help re-balance the books and effectively subsidise your other, less successful positions. In this more conservative role, leverage can actually help reduce overall risk exposure, albeit as a highly risky strategy in its own right. For this reason, it’s essential to ensure that leverage is used only as a part of your trading strategy, and does not form the sole backbone of your trading strategy.
3. Greater Profits/Losses
The ability to leverage your trading positions is particularly helpful in generating greater profits, and can play a pivotal role as part of a well-balanced, risk-managed portfolio. However, the value of leveraging any CFD position must be tempered by the risks of markets moving against a trader, and the potentially significant costs associated with wayward trades.