One of the popular forms of trading for investors is Contract for Differences (CFD) trading. However, there are still a lot of questions surrounding it. CFD trading is a contract between a buyer and seller. The buyer has to pay the seller the difference between the asset’s current value and the value at the time of the contract.
CFD trading does not use stock, commodity, foreign exchange (forex or FX), or futures exchange platforms. It offers different advantages, and the instrument has become very popular in the past decade. Let’s take a closer look at CFD trading with leverage or without.
What Is Leverage in CFD Trading
It’s essential to understand what leverage is before you start CFD trading. Opening a trade in a leveraged position involves borrowing funds from the broker and then increasing your trading position beyond what is affordable. For instance, with a 10:1 leverage and an account of $1,000, you can open a trading position of more than $10,000.
Although leverage sounds like a good way to make trades, it can also work against you. If the price moves negatively, you could lose more than your initial investment — this can cause you to lose even more money than you have.
When you start trading with leverage, the broker will ask you to deposit the margin, which is the percentage of the total value of the position. The margin requirement changes based on the asset you are trading and the leverage being used. If the value of the stock moves in your favor, you can increase your profit. But if you lose the money, you will need to deposit additional funds to keep the position open.
Trading and unleveraged CFD trading strategies have their advantages and downsides. Traders need to understand the risks related to leverage and focus on reducing and properly managing risk.
Trading With Leverage
When CFD trading with leverage, traders have the chance to increase their gains. It can also help control a larger position size with a small amount of capital. Here are the main points of how it works and the benefits:
- CFD trading with leverage increases your enhanced buying power. You can open positions that are larger than the initial investment. With a small capital of $1,000, you can gain profits and control a position worth $10,000.
- Trading with leverage also involves margin requirements, which can vary depending on the asset and your broker’s policies. The margin is the funds traders deposit with their broker to open and maintain leveraged positions.
- CFD trading with leverage also offers great potential for high returns. Even the smallest price movement can lead to substantial profits. However, it’s important to note that this can also lead to significant losses, causing financial risk.
- When you’re CFD trading with leverage, remember to focus on risk management. Leverage can increase your losses. With effective risk management strategies like proper position sizing and stop-loss orders, you can reduce the risks with leveraged trading.
Trading Without Leverage
There is also unleveraged trading, which is trading CFDs without leverage. It involves trading with the full value of the position, and you only use your own capital. There are some benefits of trading without leverage, but it still limits you to the amount of profit you can get.
- Trading without leverage takes away the risk of margin calls. Investors can only risk the capital they invest in each trade, with nothing borrowed from the broker. It also removes the risk of potential losses that exceed your initial investment.
- Some traders go for unleveraged CFD trading because it allows for long-term investments. This enables investors to capitalize on the underlying asset’s price movements without increased risk of leverage and more complexity.
- Trading without leverage makes the CFD trading process simpler. This is because traders don’t have to worry about margin requirements and other complexities that come with leveraged trading.
- Unleveraged trading is not significantly affected by short-term price fluctuations and volatility. This is because traders are not trading with borrowed funds.
Which Is Better?
Choosing whether trading with or without leverage is suitable for you depends on different factors, including investment objectives, risk tolerance, and experience level. Both approaches have their benefits and drawbacks.
Trading with leverage can be attractive if you are comfortable with higher risk and want better returns. Using leverage allows traders to control larger positions with a small amount, leading to better profits. However, it also exposes traders to increased risks and can reduce their losses.
On the other hand, trading without leverage is a lower-risk alternative. Traders don’t have to deal with the pitfalls of leveraged trading. Unleveraged trading simplifies the process, but the gains can be lower than leveraged trading.
Ultimately, deciding between trading with or without leverage depends on your risk tolerance, trading expertise, and financial goals. Novice traders can consider unleveraged trading because of the lower risk tolerance, while experienced traders have a better chance of enhancing their returns with leveraged trading.
