CFDs Leverage & Margin Trading Explanation and Example
Margin required : It is the amount of money your cfd broker requires from you to open a position. It is expressed in percentages.
Equity : It is the total amount of capital you have in your trading account.
Used margin : amount of money in your account which has already been used up when buying a cfd contract, this contract is one that is displayed in open positions. As a trader you can not use this amount of money after opening a trade order transaction because you've already used it & it isn't available to you.
In other words, because your cfd broker has opened up a position for you using the capital you have borrowed, you must maintain this usable margin for your account as a security to allow you to continue using this cfd leverage he has given you.
Free margin : amount in your account which you can use to open new trade positions. This is the amount of money in your trading account which has not yet been cfd leveraged because you've not yet opened a trade with this money - this money also is very important for you as a trader because it enables you to continue holding your open trades as will be explained below.
However, if you over use cfd leverage, this free margin will drop below a certain percent at which your cfd broker will have to close all your positions automatically, leaving you with a big loss. The cfd broker at this point closes all your position because if your positions are left open they would lose the money you have borrowed from them.
This is why you should always make sure you've a lot of free margin. To do this never trade more than 5 percent of your cfds account, in fact 2 percent is recommended.
Difference Between CFDs Leverage Set by the Broker and Used CFDs Leverage
If the set cfd leverage is 100:1, it means that you can borrow up to 100 dollars for every dollar which you have in your cfds trading account but you do not have to borrow all the 100 dollars for every dollar you have, but you can decide to borrow 50:1 or 20:1. In this case even though the leverage option set 100:1 your used cfds leverage will be the 50:1 or 20:1 that you have borrowed to make a trade.
Example:
You have 1000 dollars (Equity)
Set 100:1
CFD Leverage Used = Amount used /Equity
If you buy cfd trading lots equal to 100,000 dollars that you'll have used
= 100,000/1000
= 100:1
If you buy cfds lots equal to 50,000 dollars you'll have used
= 50,000/1000
= 50:1
If you buy cfds lots equal to 20,000 dollars you'll have used
= 20,000/1000
= 20:1
In these three cases you can see that even though the set is 100:1
The used is 100:1, 50:1, 20:1 depending on the size of cfd lots traded.
So Why not Just Choose 10:1 option as the Maximum CFD Leverage? Because to keep within proper risk management rules it is even recommended that traders use less than this?
This question might seem straight forward but it's not, because when you trade you use borrowed money known A.K.A. CFD Leverage. When you borrow capital from anyone or a bank you must maintain a security or collateral to acquire a loan, even if the security is based on monthly deduction from your salary, the same thing with CFD.
In cfd the security is known as margin. This is the capital you deposit with your broker.
This is calculated in real-time as you trade. To keep your borrowed money you must maintain what is known as the required capital (your deposit).
Now if Your CFDs Leverage is 100:1
When trading if you have $1,000 & use option 100:1 & buy 1 standard lot for $100,000 your margin on this transaction is the $1000 dollars in your account, this is the money that you'll lose if your open trade goes against you the other $99,000 that is borrowed, they will close the open cfd trades automatically once your $1,000 has been taken by the cfds trading market.
But this is if your cfd broker has set 0% CFD Margin Requirement before closing your cfds trades automatically.
For 20% requirement before closing your cfds trades automatically, then your trades will be closed out once your trading account balance gets to $200
For 50% requirement of this level before closing your cfds trades automatically, then your trade transactions will be closed out once your account balance gets to $500
If they set 100% requirement of this level before closing out your open trade positions automatically, then your trade will be closed once your trade account balance gets to $1,000: Explanation the trade will closeout as soon as you the trader execute it because even if you as a trader you pay a 1 pips spread your account balance will get to $990 & the needed percent is 100% i.e. 1,000 dollars, therefore your orders will immediately get closed out.
Most brokers don't set 100% requirement, but there are those who set 100% are not suitable for you at all, choose those set 50% or 20% margin requirements, in fact, those brokers who set it at 20% are some of the best because the likely hood they closeout your trade is reduced as displayed in examples above.
To know about this level which is calculated by your trading platform automatically - The MT4 CFD Platform will display this as "CFD Margin Requirement", This will be displayed as a percentage the higher the percent the less likely your trades are to get closed.
For Example if
Using 100:1
If cfd leverage is 100:1 & you transact cfd lots equal to $10,000
$10,000 dollars divide by 100:1, used capital is $100
Calculation:
= Capital Used * Percent(100)
= $1,000/$100 * Percent(100)
CFD Margin Requirement = 1,000 %
Investor has 980% above the required amount
Using 10:1
If cfd leverage is 10:1 & you transact cfd lots equal to $10,000
$10,000 dollars divide by 10:1, used capital is $1000
Calculation:
= Capital Used * Percent(100)
= $1,000/$1000 * Percent(100)
CFD Margin Requirement = 100 %
Investor has 80% above the required amount
Because when a trader has a higher cfd leverage means that they have more percentage above what is required(A.K.A. More "Free CFD Margin") their open cfd transactions are less likely to get closed. This is the reason why traders will choose the option 100:1 for their account but according to their risk management rules, these investors will not trade above 5:1.
These Areas are Shown on The Software Screen-Shot Below as an Example:
MT4 CFD Platform
