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Why you must respect gearing when you trade CFDs

by , 12 June 2015

The gearing aspect of trading contracts for difference (CFDs) is one of the reasons traders find them attractive.

But gearing can work against you. And that's why you must understand the risks you take on when trading CFDs and take steps to control this risk.

So what is the effect of gearing on you as a CFD trader? And how can you control the risks of trading CFDs?

Read on to find out…

What is gearing?

When you trade CFDs, you’re effectively borrowing money from your stock broker or trading company. You use this money to make your trade.

This borrowing of funds is gearing or leverage. Gearing magnifies your potential gains, but it also magnifies your potential losses.

This is why it’s so vitally important that you manage your risks when you trade CFDs, otherwise your losses could get out of hand.

When you place a CFD trade, the company you trade through demands a margin from you. This is effectively a deposit so you can place a trade.

The margin you need to put down depends on the underlying share. The more volatile the underlying share, the higher the margin requirement will be.

With CFDs, you’re looking at margin requirements ranging from around 8% to 25% of your total exposure.

Keeping your risks under control when trading CFDs,

The best way to deal with the risks that gearing brings is to use stop losses. You need to manage your risks when trading and stop losses can help you achieve this.

When using stop losses, you need to work out how much downside you’re willing to risk on each trade. You don’t want to risk a trade hitting its stop loss as it’s too close to your entry price. It’s a balancing act.

When placing a trade, you need to consider how much you’re willing to lose on it. This can help you set your stop loss for the trade.

So there you have it. Why you must respect gearing when you trade CFDs.

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Why you must respect gearing when you trade CFDs
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