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What does leverage mean for CFDs?

The British FCA (Financial Conduct Authority) stated that many traders do not fully understand the risks of trading contracts for difference (CFDs).

This is one of the easiest ways of speculating on the stock market.

CFDs and other similar financial products allow you to speculate on the future price movement of anything from the FTSE 100 to individual shares or currencies.

Trading with leverage

Leverage means that you only have to deposit a small percentage (margin) of the total value of the investment. The remainder is provided by the broker you are trading with at a specified rate of interest. However, your profits or losses depend on changes in value of the total investment. Leverage magnifies your profit, or loss on a position.

If the total value of your initial trade position is £10,000. The leverage ratio offered by a broker is 100:1. The initial margin for the trade is at 1% of £10,000, therefore you would only need to deposit £100. A market movement of 0.5% against your position, with original value of £10,000, will lead to a 50% (£50) loss against your deposited margin.

Margin close outs

There’s a high chance for your trades being closed at a loss, due to ordinary intra-day market volatility. This is because of high levels of leverage and brokers’ use of automatic margin close out. Trading positions are closed if your available margin falls below a certain level.

Gambling-style promotions

Brokers inform you of bonuses and other freebies. This is too similar to gambling-style promotions. Opportunities to win bonuses through trading or the offer of account opening bonuses or gifts. These promotions can become a distraction for traders. You have to properly assess the level of risk associated with the investment product and trade accordingly.

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