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CFDs uncovered: The pros and cons of gearing

by , 18 May 2015

Contracts for difference (CFDs), like other financial derivatives, are geared products.

So what is gearing? And what are the advantages and disadvantages of trading geared products?

Read on to find out…

Gearing explained

CFDs are geared products. This means you only put down a small proportion of the actual value you have exposure to.

You achieve gearing (or leverage) through trading on margin. You put down a small deposit (margin) to enter a trade. Gearing magnifies the movements in the underlying share price.

For example, you decide to open a CFD trade on Company ABC. The share is trading at R50. You decide to buy 100 CFDs. You have to put down a 10% margin.

In our example, you’d put down an initial margin of R5,000, but the total exposure of your trade would be R50,000. Your trading account reflects the profits or losses from the movement of your total exposure.

So what are the pros and cons of trading a geared product like CFDs?

The advantages and disadvantages of gearing

The money multiplier effect of gearing means if a trade goes the way you want it to, you can make quick, substantial profits.

But gearing also works against you. If a trade doesn’t go as planned, you can lose a lot of money.

Gearing means you don’t have to commit as much cash as you would if you’d invested in the underlying shares.

When you trade CFDs and other geared products, risk management is crucial. You need to run stop losses to protect yourself when a trade goes against you.

When trading geared products there’s a chance that you can lose more than you initially put down in a trade.

So there you have it. The pros and cons of gearing when trading CFDs.

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CFDs uncovered: The pros and cons of gearing
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