A CFD is a financial contract for difference. It can be traded on various underlyings e.g. stocks, indices, commodities, currencies and crypto currencies. With a CFD traders are only interested in the cash settlement of the difference between the opening and the closing price. With CFDs, traders are using the leverage effect, which means, that gains and losses are amplified by a multiplier (=leverage), depending on the CFDs underlying. The leverage provided from your broker ranges between 2 and 33.
Depending on the underlying CFD trader can use different leverages. However, the leverage provided to retail clients is restricted by law – hence the leverage doesn´t make a difference to pick you perfect broker as the provided leverages are the same within Europe, due to statutory regulation.
For cryptocurrencies the maximum leverage provided is 2, stocks can be traded with a leverage of 5, large indices provide a leverage of 20, whereas traders can leverage major currencies by 33.
Let´s make an example: A trader has a CFD account with a deposit of €1,000 and a want to use a leverage of 1:33 for position in major currencies. He is able to take a position up to 33 times the capital, e.g. €1,000×33 which is a total volume of €33.0000.
CFD leverage and margin
Margin and leverage are different sides of one coin. Basically, the margin enables the leverage. The margin is the amount of money the trades has to provide at least to open the position. To put it differently: You can trade a full position with only a fraction of the deposit required to open the exact same position not with a CFD but with the original underlying (e.g. original shares).
For example: A traders wants to buy 10 McDonalds shares at a price of 200 USD per share. If the trader buys the shares via his stock broker the required deposit would be 200 USD x 10 shares = 2.000 USD (disregarding any fees to the broker). If the trader buys 10 CFDs of McDonalds, the required deposit would amount to only 20%, which is 400 USD as the margin requirement for CFDs, based on McDonalds shares is only 20%, resulting in a leverage of 5.
You can calculate the margin and/or the leverage with a simple formula: Leverage = 100% / Margin%, thus the Margin% = 100% / Leverage.
Let´s make an example: The leverage provided for trading share of McDonalds is 5. Hence the margin is 20% as 100% / 5 = 20%. If a trader has to provide a margin of 5% to open a position in den German stock index DAX, the resulting leverage is 20 as 100% / 5% = 20.
A trader buys 1 lot (CFD contracts) on the DAX at 13,000 points. We assume that 1 Point in DAX has a value of €1. Let´s calculate the margin and the return of the trade: The volume of the trade is 13.000 points x €1 per point x 1 CFD = €13.000. As the DAX is a large index in Europe the margin to open a position equals 5% resulting in a margin requirement of €650.
CFD winning trade
The price goes up to 13,100 points and he closes this position. The realized gain totals (1 x €1) x (13.100 – 13.000) = €100. This is roughly a 15% return on the margin requirement of €650.
CFD losing trade
The price goes down to 12.900 points and he closes this position. The realized loss totals (1 x €1) x (12.900 – 13.000) = – 100€. This is roughly a -15% return on the margin requirement of €650.
Loss protection with CFDs
Occasionally markets can go crazy. So, what happens to a CFD trader when he is on the wrong side of a crazy market? Let´s assume the trader deposits €1.000 in his account. Over the weekend, when most of the markets are closed, some hell breaks loose, due to, let´s say, bad news in Asia. When the markets open again on Monday, the resulting loss the of traders positions would be €2.000 – but there´s only €1.000 on his bank account. In this case the resulting loss for the trader is limited to his deposit of €1.000. Thus, the trader is protected from obligations to cover the remaining loss.
Leveraged effect on CFD
Contract for difference’s leveraged effect is a solution that provides a trader with the possibility to amplify his capacity to invest. With leverage, a trader can take orders up to several times the value of his own funds. In other words, leverage is a way of trading much larger volumes than what a trader has by using only his disposable capital.
Try trading with CFDs while using a free of charge Demo-Account provided by Bernstein Bank.