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Trading CFDs: How gearing works

by , 04 June 2015

Contracts for difference (CFDs) are geared products. This means there's a money multiplier effect at work.

Gearing is both an advantage and a disadvantage. Whilst it multiplies your gains, it also multiplies your losses.

So what is gearing when trading CFDs?

Read on to find out more…


How gearing works when you trade CFDs


When you trade CFDs, gearing comes from only putting down a small amount of the total value of your chosen trade. This small amount you put down is called the initial margin.

The initial margin amount depends on the share you want to trade. It’s usually between 8% and 25% of the total value of the trade.

The gearing of a trade is dependent on the value of the initial margin and this determines the money multiplier effect. The smaller your margin amount, the more geared your trade is.

Let’s take a look at a couple of examples to see how gearing works in practise.


Working out gearing when you trade CFDs


Say you decide to buy 1,000 Company ABC CFDs. The share is trading at R50. This means the total value of the trade is R50,000.

If you need to deposit a 10% initial margin to open the trade, in other words R5,000, you’re ten times geared (R50,000/R5,000). Every cent movement of the underlying share price is magnified by ten due to this gearing.

On another day, you decide to buy 1,000 Company XYZ CFDs. The share is also trading at R50, meaning the total value of the trade is R50,000.

If you need to deposit a 15% margin to open the trade, in other words R7,500, you’re 6.7 times geared (R50,000/R7,500). Every cent movement of the underlying share price is magnified by 6.7 due to this gearing.

These examples show that the higher the margin amount, the less geared the trade is.

So there you have it. How gearing works when you trade CFDs.

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Trading CFDs: How gearing works
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