Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when spread betting and/or trading CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.

Leverage in trading: how does it work?

Published on: 02/11/2021 | Modified on: 16/09/2022

Leverage is the use of a smaller amount of capital to gain exposure to larger trading positions, also known as margin trading. It can be used across a variety of financial markets, such as forex, indices, stocks, commodities, treasuries and exchange-traded funds (ETFs). As an example, leveraged stock trading is an appealing choice for investors that don’t want to pay the full value of the share upfront or take ownership of the asset. In this article, we will explain what it is, how it's calculated and how you can use it to gain enhanced trading exposure across 12,000+ instruments on our trading platform.

KEY POINTS

  • Leverage and margin are essentially the same thing
  • It provides greater exposure to the financial markets, as you don’t need to pay the entire trade value upfront
  • Examples of leveraged products are spread bets and contracts for differences
  • It is calculated by a ratio, such as 5:1 for stocks (which is relatively low) or 30:1 for forex (which is relatively high)
  • If trades are successful, profits may be magnified but if they are unsuccessful, losses will be magnified by an equal amount

What is leverage in trading?

Leveraged trading is the use of a smaller amount of capital to gain exposure to larger trading positions via the use of borrowed funds, which is also known as margin trading. It can magnify potential profits, but can equally increase losses, so trading and risk-management strategies should be used.

Understanding the difference between the two can sometimes cause confusion. It is important to realise that margin is the amount of capital that is required to open a trade. Learn more about margin accounts​.

A leverage ratio of 10:1 means that to open and maintain a position, the necessary margin required is one tenth of the transaction size. So, a trader would require £1,000 to enter a trade for £10,000. The margin amount refers to the percentage of the overall cost of the trade that is required to open the position. So, if a trader wanted to make a £10,000 trade on a financial asset that had a ratio of 10:1, the margin requirement would be £1,000.

Leverage can sound like a very appealing aspect of trading, as winnings can be immensely multiplied. But it is a double-edged sword – it is important to remember that losses can also be multiplied just as easily.

It is important for all traders to bear in mind the risks involved. Many traders see their margin wiped out incredibly quickly because of a ratio that is too high. Novice traders should be especially careful when practising margin trading. It is best to be more prudent and use a lower ratio. A lower ratio means traders are less likely to wipe out all of their capital if they make mistakes.

How does leveraged trading work?

To start trading, it is advisable that a trader starts with a ratio that is lower than their maximum leverage allowance. This enables traders to keep their positions open for the full size, even if they are experiencing negative returns.

This type of trading is more likely to be adopted by those trading short-term price movements​. It would be much less suitable to anyone investing long-term, for example over multiple years or even decades. In this instance, a ‘buy and hold’ approach would be more suitable. In this instance, a ‘buy and hold’ approach would be more suitable.

Example of leverage in stock trading

For example, let’s say a trader has a maximum leverage of 5:1 and opens a position on Apple shares on a $10,000 account. The trader now has a position size with an asset value of $50,000, which has given them trading exposure to 5 times as many shares when compared with if they had purchased the assets outright without leveraging their starting capital of $10,000.

To maintain this position in Apple stock, the value of the trader’s account would need to stay above the maintenance margin requirement of 50%, or 5,000 in this example.

Read more about maintenance margin​ and margin calls​.

Spread bet and trade CFDs using leverage

What are some products you can use?

Leveraged products are derivative instruments that are worth more on the market than the deposit that was initially placed by an investor. The two significant products that we offer are spread betting and contracts for difference (CFD trading). When trading with leverage on either of these products, an investor can place a bet using a reasonably small margin on which way their chosen market will move. The investor technically does not own the underlying asset, but their profits or losses will correlate with the performance of the market.

The key difference between spread betting and CFD trading is that the former is exempt from capital gains tax (CGT), while the latter requires you to pay this tax*. CFD traders will also have to pay a commission charge in addition to the spread when trading shares. To calculate your profits or losses, you must find the difference between the price at which you entered and the price at which you exited. For spread betting, this figure should then be multiplied by the stake, and for CFDs, it should be multiplied by the number of CFD units. Both are at risk of financial loss, but equally, financial gain if the market moves in a favourable direction. Spread betting is only available to customers residing in the UK or Ireland, whereas CFDs can be used globally.

Read more about our CFD commission rates​ here, along with our article on CFD meaning​.

Leverage ratios in the financial markets

Currency trading

Forex trading​ is the buying and selling of foreign currencies across the global market. Forex leverage ratios start relatively high compared to other markets at around 30:1, meaning that there is a high opportunity for profit or loss, depending on how you look at it.

Indices

Indices​ represent the overall price performance of a group of assets from a particular exchange. Commonly traded indices include the FTSE 100, S&P 500 and the Dow Jones 30. Indices tend to have quite low margin rates and therefore high ratios of approximately 20:1.

Leveraged stock trading

Another market with a relatively low ratio is share trading​, where we offer spread betting and CFD trading prices on 9,000+ international shares. Ratios starts from 5:1 or a 20% margin rate for major international stocks such as Apple, Tesla and Amazon. This applies to the lowest tier of between 0-13,600 units. When you open a position above this amount, the margin rate will increase, subsequently decreasing the ratio that you can trade with.

Leverage ratio formula

An important aspect is understanding how to calculate the ratio. The following formula is commonly used and easy to remember:

L = A / E

where L is leverage, E is the margin amount (equity) and A is the asset amount.

Therefore, dividing the asset amount by the margin amount gives the ratio.

How do you calculate leverage ratios?

It is also possible to start with the margin amount and apply a leverage ratio to determine the position size. In this instance, the formula would be A = E.L. Therefore, multiplying the margin amount by the ratio will give the asset size of a trader’s position.

Most traders distribute risks across different markets, meaning they are not putting all their capital into one trade. This is done by opening various positions in different markets. When this is the case, there may be the need to do calculations to determine net asset value or the accumulative value of a trader’s positions. Thanks to platform technology that most brokers will offer, it is easier to monitor all parameters and open or close individual positions as needed. More importantly, it can help a trader work out if positions fit within their total amounts, which should be less than the maximum leverage allowed by the broker.

Test out our leverage trading platform

As discussed, we have differing leverage ratios and margin rates for each type of financial market and asset. All products are available on our award-winning trading platform​**, Next Generation, where you can put into place risk management tools, such as stop-loss and take profit orders. Familiarise yourself with our platform now by creating a live account, or practise first with virtual funds on a demo account, which is included for free upon registering.

Can you spread bet using leverage?

Spread betting is the most popular product on our platform, which you can use to trade an endless array of financial assets. As discussed, you must use leverage when spread betting our products, which can bring risks. This is why we offer you the chance to familiarise yourself with the platform on our demo account before depositing real funds. Below, we explore the risks of spread betting in more detail.

How to trade the financial markets

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What are the risks involved?

The most important thing to understand is the risk involved. Risk is inherent to any type of trading, however, leverage can cause both magnified profits and losses. It would be prudent for traders to pay particular attention to choosing how much leverage they will use. The ratio should be determined in advance of trading. It is very tempting to trade in a larger size than what was originally determined if you have a streak of winning trades.

Doubling your risk on a one-off basis could benefit a trader if they happen to get that one-off trade right. But get it wrong and a trader could end up facing a much larger loss than usual. To help reduce risks in trading, you should plan out your trading strategy​ in advance.

Two factors could be taken into consideration when determining what amount of leverage to apply to a portfolio: how much risk to take per trade and how much risk to take per day. Examining this via percentages makes things easier. First, a trader can determine how much risk they are willing to take per day. This involves deciding the maximum amount that you are willing to lose. This could, for instance, be between 1% and 2%. If a trader were using 2% as maximum daily risk, it would take 50 days of bad losing trades in a row to wipe out their capital, which is hopefully extremely unlikely to happen.

A trader should also determine how many trades they want to place per day. This could be a set number or a maximum number. For example, a trader may decide that whatever the market, they will make a maximum of three trades a day. In each case, the trader can divide the percentage they are willing to risk per day by this number.​

Tips for risk-management

A popular risk-management tool to be considered when trading with leverage is a stop-loss. By implementing a stop-loss order to your position, you can limit your losses if your chosen market moves in an unfavourable direction. For example, a trader may choose a pre-determined figure that they do not want to surpass, meaning that your stake in the instrument will be sold at the given price. However, please note that basic stop-losses are susceptible to market gapping and slippage.

Guaranteed stop-losses​ work exactly in the same way as basic stop orders, although investors can choose to pay a small fee to guarantee the closing of a trade at the exact price specified. This way, if you have used a particularly high ratio in the trade, there will be less chance of multiplying your losses, regardless of market volatility.

Read more about how to protect your money in trading with our risk-management guide​.

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FAQs

How does leveraged trading work?

Spread betting and CFD trading are leveraged products, meaning that only a percentage of capital is necessary to open a position and get exposure to a much larger sum of money in the trade. This means profits and losses are amplified, as they are determined by the full trade value. Find out about leverage in forex trading.

What are the margin rates with CMC Markets?

The leverage rate or margin requirement varies based on the instrument (EUR/USD, UK 100, Gold) and asset class (forex, indices, commodities). We offer margin rates on forex from 3.3%, which is known as 30:1 leverage. This means you can open a position worth up to 30 times the amount of deposit you lay down. Our additional margin rates include indices at 5%, commodities from 5%, shares at 20% and treasuries at 3.3%. See our range of financial markets for more information.

What are the risks of leverage?

When you trade with leverage, you gain full exposure to the full trade value with a small initial outlay. Therefore, your profits and your losses are amplified. This means you can lose more than your initial outlay amount and may need to add additional funds to keep your trades open. This is known as a margin call. You could also exit other positions, or reduce your exposure on other trades to keep that trade open. Find out how to manage risk when trading with leverage.

What is the relationship between margin and leverage?

A margin requirement is the deposit amount needed to gain full exposure to a trade, expressed as a percentage. Leverage shows a trade’s deposit ratio relative to the full trade amount. For example, a £10,000 trade with a margin requirement of 1% would require £100 to place that trade. The leverage ratio for this trade is 100:1, as the 100:1 expressed as a percentage is 1%. See our page on calculating margin rates for full workings.


*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.
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