EURUSD 1.1787 USDJPY 112.14 USDCAD 1.2774 EURCZK 25.557 USDCZK 21.677 EURPLN 4.2304 USDPLN 3.5887
EURUSD 1.1787 USDJPY 112.14 USDCAD 1.2774 EURCZK 25.557 USDCZK 21.677 EURPLN 4.2304 USDPLN 3.5887

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Financial leverage allows potentially higher returns from the investment to be achieved, in return for undertaking higher risks than in the case of standard investments

Rule of thumb

Higher financial risk always means the possibility both to gain a higher profit, as well as a loss

In order to operate with CFD instruments, it is enough to provide only a part of the nominal value as a deposit (margin). For currencies, it can be as low as 1% of the nominal value of the contract, in general depending on the type of the underlying asset.

 

In such a case:

  • 1 contract on the USDCHF, nominal value 100 000 USD, deposit = 100 000 USD * 1% = 1000 USD, assuming the USDCZK rate is 20,  is equal to 20 000 CZK.
  • 0,1 contract on GBPUSD, nominal value 10 000 GBP, deposit = 10 000 GBP * 1% = 100 GBP, assuming the GBPCZK=30,  is equal to 3 000 CZK.

 

In other words, the financial leverage is the relation of the margin to the nominal value of the transaction. If the specification of the contract says there is a 1%  margin required, the maximum leverage in such a case is 1/100. It can be called maximum, as in fact all the money that is available on the account  at the given  time can be used as the margin for  an open position.

 

Example

How does it work in practice? Let us consider a trader that has 100 000 CZK on  a trading account, with no positions open. The trading platform will show that both the Balance and Equity are equal to 100 000 (CZK). In order to open a 0,1 contract of GBPUSD, one would need at least  a margin of 3 000 CZK. Please take note that in this case, as there are no other positions open, all the money on the account can be used as the margin for the new position. That means that in practice, in this case the leverage actually used is lower than 1:100 and equal to:

 

Actual leverage = available margin 100 000 CZK / nominal value (10 000 GBP * GBPCZK 30) = 100 000/300 000 = 1/3

 

Please take note that once such a position  is open, the trading platform would report that the Margin is equal to 3000, Free Margin = 97 000 and Margin Level is 3333%. The Margin Level shows the relation of the sum of Margin and Free Margin available on the account to the Margin required for an open position.

  

In order to summarise, the mechanism of financial leverage allows freedom to operate with Contracts for Difference (CFDs) with significantly higher nominal values than the actual deposit placed physically on the brokerage account of the investor. This provides the possibility to undertake significantly higher financial risk than in the case of more conventional instruments, such as shares. 

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