Yahoo7 Finance

Case study

Jim has done well with his Australian equity portfolio given its strong performance over the last few years.

He has heard that leverage is a double-edged sword, magnifying returns as well as losses. Instead of borrowing he wants to use CFDs.

Gearing levels can be calculated simply by comparing the amount of capital (generally the amount in your trading account) to the value of open positions. To illustrate, if you have $10,000 in your trading account and hold $50,000 worth of positions then you have a gearing level of 5 times your capital ($50K/$10K= 5x).

Practical example: PBL

The following tables illustrate the power of leverage. The examples below demonstrate how a $300 initial outlay can give an exposure of $10,000 (leverage = 33x). As a general rule, leverage of 3x to 5x is considered the norm. The first table shows how profits can be magnified using CFDs.

In this example, the position is held overnigt. Interest on the CFD trade is charged to your account at the rate of 8.25% p.a.(currently 8.50% p.a.) based on the end of day price of the CFD for the number of days the position is held over night. The opportunity cost on the share position is based on 6% p.a.

Risk

With greater leverage comes greater exposure to adverse market movements. As mentioned earlier this can be a double edged sword magnifying your returns and your losses.

Summary:

When the market is doing well, a higher level of leverage may be appropriate. However, it may be difficult or even impossible to determine when market conditions will change. This can expose you to large losses. For this reason it makes sense not to gear too highly and use risk management orders where appropriate.

More about CMC Markets CMC Markets is a pioneer of CFD trading in Australia. Our goal is to empower Australian traders by giving you access to CFDs over Australian and global markets and the ability to trade on leverage and potentially profit in almost any market condition. We run regular CFD introduction seminars and education courses around Australia for traders new to CFDs and are committed to providing a cost effective CFD trading service. Click here for more info or to start trading CFD's.