When it comes to trading CFDs and forex, one of the most attractive features is leverage. Leverage allows traders to control large amounts of capital by putting down a smaller amount. It has opened markets like commodities and forex to more retail traders who don’t want to allocate large amounts of capital to each position. However, it is important to understand how leverage and margin work before getting started.
Leverage and Margin Explained Leverage is a tool used by traders to control a large amount of capital by putting down a much smaller amount. Unlike traditional investing, where you must pay for the full value of your position upfront, with leveraged trading you only have to pay a deposit known as your margin. For instance, with 50:1 leverage, you can use €1 to control a position worth €50. Margin, on the other hand, is the capital that you have to put down to open a leveraged trade. Different markets will have different margin requirements.
CFD trading is a popular way of accessing leverage when buying and selling shares, indices, forex, and more. Margin will multiply both your profits and your losses. Therefore, using orders as part of a comprehensive risk management plan is crucial when using leverage.
Margin Calls Explained Margin calls are something that traders should always be aware of. Traders must ensure they have enough margin in their account to cover the cost of their open trades. If they don’t, then they could quickly find themselves on a margin call, which means their positions will be at risk of being closed out. If a trader drops below 50% of their margin requirement, their position will be closed automatically. At this point, they will have three options: close out their position, reduce the size of their trade to free up some equity in their account, or add additional funds to their account to cover the shortfall in margin plus additional funds to sustain any further losses.
Leverage Costs Explained Traders have to pay to open a leveraged trade via either commission or the spread. With commission, the costs are separate, while with the spread, they are incorporated into the bid and ask prices. Traders also pay borrowing costs on positions that they keep open for more than a single day. This is called overnight financing. Overnight financing is essentially an interest payment to cover the cost of your leverage. It is charged each day that the trade is open, and the cost is already incorporated into the spread with forwards.
Calculating Overnight Financing To calculate overnight financing on a long position, traders take its size at the end of the day and multiply it by €STR plus 2.5%. Then they divide that figure by 365 to get a daily rate. The FOREX.com platform makes it easy to see the overnight financing charge for any market by looking at the Market 360 tab.
Conclusion Leverage is a tool that allows traders to control a larger position than they would be able to with their available capital. However, it is important to understand how it works and its risks. Traders need to be aware of margin calls and borrowing costs on positions that they keep open for more than a single day. The FOREX.com platform can help with calculating overnight financing and keeping track of the costs of your trades. With a solid understanding of leverage, margin, and risk management, traders can make the most of the opportunities presented by leveraged trading.
