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CFD trading revealed: How the margin gears your trade up

by , 27 January 2014

Contracts for difference (CFDs) are geared products. And you achieve that gearing effect because you trade on margin. By only putting down a fraction of your exposure, you gain or lose depending on the performance of the underlying. Let's take a closer look at how the margin works when you trade CFDs…

As contracts for difference (CFDs) are geared products, it means you gain exposure to much more than your margin (or deposit) covers you for, Mark Weetman in The Ultimate Guide to Trading Contracts for Difference explains...

The market maker decides on the margin required for each CFD. This margin usually ranges from 9% to 25% of your overall exposure.

By putting down a small deposit, you benefit from the movement of the total exposure. If the margin requirement was 10%, you would put down one tenth of the total value of whatever share you were trading.

An example of the margin in action

Here’s how the margin works…

Let’s say Company ABC was trading at R350 per share. You decide to buy 100 Company ABC contracts. This means your overall exposure is R35,000. You will gain or lose depending on the performance of Company ABC.

Because of the gearing aspect of CFDs, you only have to put 10% of your overall exposure down to enter the trade. A great reason to trade contracts for difference.

Using our Company ABC example, you only need to maintain the margin of R3,500.

You’re benefiting from the movement of the shares, but you only have to put down a fraction of the capital.

If you called your stockbroker and purchased 100 actual shares, you’d have to put up the full amount of R35,000.

Geared products have the benefit of multiplying the shares’ underlying movements, but of course this means your risks are also higher. If a trade goes against you, you can end up losing more money than you initially put down. That’s why risk management is so important when you trade.

The initial margin you put down to enter your CFD trade is a certain percentage of the full value of the transaction. Going back to our Company ABC example, the initial margin was 10%. This means you would have to deposit R3,500 of the full nominal value of R35,000.

The company you trade CFDs with uses this margin as security for your position. They will use it to offset any losses on your position for as long as you hold the CFD trades.

So there you have it, how the margin works when you trade CFDs.

CFD trading revealed: How the margin gears your trade up
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