How gearing works when you trade contracts for difference (CFDs)
When you trade contracts for difference (CFDs), one of the major motivating factors for this is the money multiplier effect that's at work. This money multiplier effect is gearing. But how can you calculate the gearing of your trade? Let's take a closer look at how gearing works with CFD trading…
Contracts for difference (CFDs) are geared products, the research team at FSP Invest
in The Ultimate Guide to Trading Contracts for Difference
It is the gearing aspect of CFDs that means you can make big gains on small rises and falls in a share price. Equally so, you can also make big losses on small rises and falls in a share price.
That’s why it’s so crucial you understand what gearing is.
What are geared products?
CFDs are geared products. This means there are money multiplier effects at work.
Gearing is what magnifies your returns 10 times or more. Gearing is essentially the borrowing of funds to purchase a financial instrument.
You do this by trading on margin. This means you’re leveraged and for each cent the share moves in your favour, you’re multiplying the profits by up to 10 times.
How to calculate the gearing of your trade
You can calculate the gearing of your trade easily. Just take the value of the overall exposure and divide it by the margin you put down to open your trade.
For example, you decide to purchase 1,000 Company XYZ CFD contracts. The share is trading at R38. This means your overall exposure would be R38,000.
Because of the gearing aspect, you’ll put down a percentage of that as margin. In this case, let’s say it’s 10%. So you’d put down R3,800.
To calculate the gearing of your trade, you’d divide your overall exposure by your margin amount, (R38,000/R3,800). This means you’re effectively 10 times geared.
So there you have it, how gearing works with CFD trading.