How Leverage and Margin Work in CFD Trading

Why leverage and margin matter

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Leverage and margin are two sides of the same idea, and they sit at the heart of CFD and forex trading. Leverage lets you control a position that is larger than the money in your account. Margin is the amount of your own money set aside to open and keep that position. Understanding how they interact is one of the most important steps in managing risk, because leverage changes how quickly your account balance can rise or fall.

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What is margin?

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Margin is a deposit, not a fee. When you open a leveraged position, a portion of your account balance is reserved as collateral. There are a few related terms you will see on most trading platforms:

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• Initial (required) margin: the amount needed to open a position, usually expressed as a percentage of the position's full value.
• Used margin: the total margin currently tied up in your open positions.
• Equity: your account balance plus or minus the unrealised profit or loss on open positions.
• Free margin: equity minus used margin, which is what remains available to open new positions or absorb losses.
• Margin level: equity divided by used margin, shown as a percentage. Providers use this figure to decide when to warn you or close positions.

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What is leverage?

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Leverage is usually written as a ratio, such as 10:1 or 30:1, and it is directly linked to the margin requirement. A 10% margin requirement is equivalent to 10:1 leverage, because you put up one tenth of the position's value. A 5% margin requirement is equivalent to 20:1, and so on. The higher the leverage, the smaller the deposit needed to open the same size of position.

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A worked example

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Suppose you want to open a position worth 10,000 units of your account currency on a market with a 5% margin requirement, which is 20:1 leverage. The margin required is 500. Now consider what happens when the price moves:

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• If the market moves 1% in your favour, the position gains 100. That is a 20% return on the 500 margin.
• If the market moves 1% against you, the position loses 100. That is a 20% loss on the 500 margin.
• If the market moves 5% against you, the loss is 500, which is the entire margin for that trade.

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These figures are illustrative and ignore costs, but they show the key point: leverage does not change how much the market moves, it changes how much that movement affects your account. A 1% move can mean a 20% swing in the money you committed. Higher leverage does not make a trade more likely to succeed; it only makes the outcome larger in both directions.

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Margin calls and stop-outs

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As a leveraged position moves against you, your equity falls and so does your margin level. Providers typically set two thresholds. At the first, often called a margin call, you are warned that your account is close to its limit and may need more funds or fewer open positions. At the second, often called a stop-out or close-out level, the platform begins closing positions automatically, usually starting with the largest losing trade, to stop the account falling further.

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Automatic close-outs happen at the prevailing market price, which in fast markets may be worse than you expect. The exact thresholds vary between providers and account types, so check them in your provider's terms before you trade.

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Can you lose more than your deposit?

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This depends on the provider and where you live. Some providers and jurisdictions offer negative balance protection, which means your losses are limited to the funds in your account. Others do not, and in a sharp gap a position could be closed at a loss larger than your balance. Read your provider's terms carefully to understand how this applies to your account, and never assume protection that is not stated.

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Practical ways to manage leverage

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• Size positions by risk, not by available margin. Just because the platform lets you open a large position does not mean you should. Decide how much of your account you are willing to risk on one trade and size the position from that.
• Use stop-loss orders. A stop-loss closes a position at a predefined level. It can help limit losses, although in a gap the order may be filled at a worse price than the level you set.
• Watch your margin level. Keep enough free margin so that normal price swings do not push your account towards a stop-out.
• Consider lower effective leverage. Opening smaller positions relative to your balance reduces the impact of each price move, even if higher leverage is available.
• Account for overnight costs. Leveraged positions held overnight usually incur financing charges, which reduce returns over time.
• Practise first. A demo account lets you see how margin and equity change as prices move without risking real money.

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Leverage limits and regulation

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Many countries cap the leverage that retail clients can use, often with different limits for different asset classes, because higher leverage is associated with faster losses. The rules that apply to you depend on where you live and on the provider you use. Check the requirements in your jurisdiction and your provider's own documentation before trading.

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This article is general educational information, not investment advice or a recommendation to trade. CFDs are complex, leveraged products and you can lose your money rapidly. Past performance is not a reliable indicator of future results. Make sure you understand how CFDs work and whether you can afford the risk, and check that trading these products is permitted where you live.