Understanding Leverage and CFD Risk

Leverage lets you take a market position larger than the cash you have committed. A contract for difference, or CFD, is one common way of doing that: instead of owning the asset, you enter an agreement with a provider to exchange the difference in price between opening and closing. You never own the share, the barrel of oil or the coin.

The arithmetic, written out

Round numbers, and not a prediction of anything.

Notice what did not happen in the last line. There was no crash, no fraud and no mistake. A 15% overnight gap is unremarkable in some instruments. Leverage did not create the move; it decided how much the move cost you.

Margin calls and close-outs

Providers monitor whether your remaining margin still supports the position. If it falls below a threshold you may receive a margin call — a request to add funds — or the position may simply be closed automatically. Two consequences follow.

• You can be right and still lose. If a position is closed during a temporary dip, you take the loss even if the price recovers an hour later. Being correct about the destination does not help if you are removed from the journey.
• Adding funds to hold on is a decision, not a rescue. It increases the amount at risk in a position that has already moved against you. People routinely make this decision under time pressure, which is the worst possible condition for it.

The costs that are easy to miss

• Spread. You buy at one price and sell at a slightly worse one. On a leveraged position this cost is calculated on the full position size, not on your margin.
• Overnight financing. Holding a leveraged position typically incurs a daily charge, because you are effectively borrowing. Over weeks it compounds quietly.
• Slippage. In fast markets your order may fill at a worse price than requested, including a stop order.
• Currency conversion. If the instrument is priced in another currency, conversion happens somewhere and is charged somewhere.

Together these mean a leveraged position needs the market to move in your favour just to break even. That is not a scandal — it is the product working as designed — but it should be in front of you before you start, in writing.

Why stop orders are not guarantees

A stop order instructs the provider to close a position if the price reaches a level. It usually works. It does not work when the market gaps past the level without trading, or when liquidity disappears and there is no buyer at your price. Some providers offer guaranteed stops for a fee; ask whether that is available, what it costs and exactly what it covers.

Questions to put to a provider, in writing

• What is the maximum leverage on my account, and can it change without my agreement?
• Is there negative balance protection, and what exactly does it cover?
• What is the margin call level and the automatic close-out level?
• What is the full cost schedule: spread, commission, overnight financing, conversion, inactivity?
• Are guaranteed stops available, and at what cost?
• Which entity holds my money, under which licence, and in which country?

If any of those answers are vague or verbal only, treat the vagueness as the answer. Our Australia page sets out the checks in order, and risk and safety covers why no risk control can guarantee an outcome.

Is it suitable?

Leveraged products are not suitable for money you cannot afford to lose, for money you will need on a fixed date, or for anyone who would find a fast adverse move distressing. Deciding that leverage is not for you is a completely reasonable conclusion, and it is one that a lot of marketing is designed to prevent you from reaching.

Murray Capholm does not offer leveraged products, does not hold client money and does not place trades. We can explain how these products work; whether to use one, and with whom, is your decision and the provider’s agreement.