CFD trading with leverage - How does it work?

CFD trading refers to trading in CFDs (or contracts for difference). These belong to the derivative financial instruments and reflect the mutual performance of two investment parties or a single asset. The underlying asset is therefore not purchased directly in CFD trading, but speculated on its price trend.

The potential investor can either realize the CFD trade completely with equity capital or he can use borrowed capital for a short time - a so-called CFD leverage. This is short-term borrowed capital, through which larger shares of CFDs can be acquired for trading than would be possible only with their own funds. For this, the potential trader must deposit a margin - an interest payment for the entire term of the trade.

Leveraged CFD trading offers itself to many investors as a lucrative business model, which is also associated with high risks, since a total loss is possible at any time. In the following sections, the reader will learn all the information about CFD leverage, what can be traded leveraged, individual risk management and how to learn leveraged CFD trading on the demo account.

How CFD trading with leverage works

First, the trader decides on an individual leverage - for example 1:2, 1:5 or 1:10. The number with which the "1" is set in relation describes the amount of borrowed capital taken up for the trade with the broker. If, for example, 1,000 euros of equity is traded and a leverage of 1:10 is used, the trader trades briefly with 10,000 euros. For this, however, he must deposit a margin with the broker.

The amount of the margin depends on the leverage and usually varies between 3 and 50 percent. This amount is then blocked on the trader's own securities account during the trade and cannot be used for parallel trades. As soon as the trader liquidates his leveraged position again, he gets his margin back from the broker, minus or in addition to the profit achieved.

The danger of leveraged CFD trading: The borrowed capital for the trade and the deposited margin naturally bear the risk of total loss at any time. A total loss means that the trader has used up the margin deposited with the CFD broker. If the trader does not close any other CFD positions or does not add any money, the CFD broker automatically closes the CFD.

What is leverage anyway?

In the financial industry, leverage is a proven means of achieving high profits with relatively small amounts of equity. As a rule, a fraction of the leverage amount must be deposited as collateral (or "margin"). The trader can now buy a much larger volume of CFDs with the larger volume of money (margin + leverage), which offers these significantly higher profits, but just also greater losses.

In short, leverage is a kind of "short-term loan" for CFD traders to increase their invested capital.

These markets can be traded with leverage

There are numerous trading classes on the financial market that can be traded leveraged. In addition to pure CFD trading, this also applies to the following assets, among others. According to new EU regulations, there are clearly defined standard levers for the asset classes:

• Individual shares (standard leverage: 1:5)
• ETFs (standard leverage: 1:10)
• Indices (standard leverage: 1:10)
• Forex (standard leverage: 1:30)
• Commodities (standard leverage: 1:10)
• Cryptocurrencies (standard leverage: 1:2)

Consequently, the standard levers differ from asset to asset and are set due to the different risk classes. The standard levers have been regulated by ESMA and apply to all CFD brokers in the EU. Only with a professional account you can use higher levers. This regulation of CFD levers serves to protect investors.

This is how leveraged trading affects CFD trading

The use of leveraged CFD trading can of course turn out to be a real profit accelerator for the trader. In the following, we will show three different scenarios of how profitable CFD trading with pure equity is compared to leveraged trading (1:5 and 1:10):

Scenario 1: CFD trading with equity only

Trader A invests exactly 10,000 euros in any CFD. This increases during the trade by 10 pips (fourth digit after the decimal point). The value of the underlying asset was exactly 100 euros at the time of purchase. This results in the following calculation: 10,000 euros x 0.0001 x 10 pips = 10 euros. The trader therefore earns exactly 10 euros on this trade.

Scenario 2: CFD Trading with a 1:5 Standard Leverage

Trader B also invests 10,000 euros in any CFD. At the same time, however, he uses 5 times the amount of his own capital in the form of borrowed capital. Thus, he trades with a total of 50,000 euros, but only has to spend 10,000 euros of his own funds. This in turn results in the following calculation: 50,000 euros x 0.0001 x 10 pips = 50 euros. Compared to scenario 1, the trader in scenario 2 has generated a 5-fold higher profit with the same capital investment.

Scenario 3: CFD trading with 1:10 leverage

Of course, the effects from scenario 2 are even more pronounced in scenario 3, since here the amount traded is 10 times the amount of equity invested. If 10,000 euros are also invested here and the 10-fold amount is traded leveraged, the following calculation results for Trader C: 100,000 euros x 0.0001 x 10 pips = 100 euros. The profit in scenario 3 would therefore be 10 times that in scenario 1, but without having to invest more equity.

Do higher CFD levers always automatically mean higher risk?

While potential traders used to run the risk of being subject to margin calls through a leveraged trade, this is no longer the case in the EU since 2021. ESMA issued a ruling in this regard that all CFD brokers operating in the European Union may no longer require margin calls.

For the investor, this means that the maximum achievable loss on a trade with borrowed capital is a veritable total loss. As soon as the trade reaches the value of the total loss, the position is automatically closed by the broker. Thus, the trader no longer runs the risk of losing more money on his trade than the sum of the equity capital used and the borrowed capital for the trade.

You can find out exactly how the leverage affects your CFD position with our CFD Calculator for Leverage & Margin calculate quite simply.

Are there ways to reduce individual risk in leveraged CFD trading?

In CFD trading, the potential investor is provided with numerous tools and strategies on how to considerably reduce his individual risk in leveraged trading. Here are some of the most effective tools and strategies:

• trading with the order command Stop Loss (in this case, the broker automatically closes the position at a maximum tolerable loss value predefined by the trader).
• only one small margin deposit with each trade (keyword: money management)
• Positions not hold overnight (Risk of a "gap" - i.e. a jerky price drop at the beginning of the next trading day).
• practice on a demo account first
• Knowledge of the Chart analysis to better assess markets
• Experience in CFD trading

Conclusion: It is best to learn the effects of leveraged CFD trading on a demo account

Ideally, potential traders first gain experience in dealing with leveraged trading - on free demo accounts that brokers make available. Such a demo account can be used to participate in prices with the help of play money.

It is therefore an excellent way to test the psychological effects as well as the strategic realities of leveraged trading without any immediate risk. As soon as the play money on the demo account is used up, it can be replenished without any problems. A demo account is therefore an indispensable tool to learn leveraged trading in a safe environment.