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I'm a newbie in trading and I've been reading about the financial leverage mechanism when trading CFDs. From what I got it works by letting me trade on margin by moving greater amount of money lent by the brokers.

I also got that I'm responsible with all the money in my investment account in case the investment goes awry.

What I don't get is why a broker would want to lend me more money than what I have in my investment account to let me do the trading... a bank doesn't lend you money if it hasn't made sure that you can repay your debt in full (plus interests).

What's the catch here?

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a bank doesn't lend you money if it hasn't made sure that you can repay your debt in full (plus interests).

That's not entirely correct. The bank issues a lot of loans and expects almost all people will pay their debts. The few people who go bankrupt and cannot pay are (more than) compensated for by the people who do pay their debts.

The same holds for brokers, e.g. here is an example of the rates they calculate when you trade on margin, effectively borrowing money from them.

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    I think a simple note on security would be valuable. Because the broker controls your assets, you are a lower risk than simply asking for an unsecured loan from the bank - you effectively provide full security over your margin amount, because if you shirk your debts, the broker can simply cash your assets and recover the funds without your say-so. This is similar to how a bank gives you a mortgage because they retain rights to foreclose your house if you fail to pay; the difference is that the broker can liquidate your account immediately with minimal hassle. – Grade 'Eh' Bacon Jun 14 '17 at 15:11
  • Also note that the OP is talking about CFD accounts not margin accounts, even though CFDs are traded on margin they are different. – Victor Jun 14 '17 at 22:35
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A CFD broker will let you open a trade on margin as long as your account balance is more than the margin required on all your open trades. If the required margin increases within a certain percentage of your account balance, you will get a margin call. If you then don't deposit more funds or close losing trades out, the broker will close all your trades.

Note: Your account balance is the remaining funds you have left to open new trades with.

I always use stop loss orders with all my open trades, and because of this my broker reduces the amount of margin required on each trade. This allows me to have more open trades at the one time without increasing my funds.

Effects of a Losing Trade on Margin

Say I have an account balance of $2,000 and open a long trade in a share CFD of 1,000 CFDs with a share price of $10 and margin of 10%. The face value of the shares would be $10,000, but my initial margin would be $1,000 (10% of $10,000).

If I don't place a stop loss and the price falls to $9, I would have lost $1,000 and my remaining margin would now be $900 (10% of $9,000). So I would have $100 balance remaining in my account. I would probably receive a margin call to deposit more funds in or close out my trade. If I don't respond the broker will close out my position before my balance gets to $0.

If instead I placed a stop loss at say $9.50, my initial margin might be reduced to $500. As the price drops to $9.60 I would have lost $400 and my remaining margin would now only be $100, with my account balance at $1,500. When the price drops to $9.50 I will get stopped out, my trade will be closed and I would have lost $500, with my account balance still at $1,500.

Effects of a Winning Trade on Margin

Say I have the same account balance as before and open the same trade but this time the price moves up.

If I don't place a stop loss and the price goes up to $11, I would have made a $1,000 profit and my remaining margin will now be $1,100 (10% of $11,000). So my account balance would now be $2,000 + $1,000 - $1,100 = $1,900.

If I had placed a stop loss at say $9.50 again and the price moves up to $10.50, I would have made a profit of $500 and my margin would now be $1,000. My account balance would be $2,000 + $500 - $1,000 = $1,500.

However, if after the price went up to $10.50 I also moved my stop loss up to $10, then I would have $500 profit and only $500 margin. So my balance in this case would be $2,000 + $500 - $500 = $2,000.

So by using stop losses as part of your risk management you can reduce the margin used from your balance which will allow you to open more trades without any extra funds deposited into your account.

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  • Your phrasing is a little confusing here, you don't explain why your balance would go down when the value goes up - ie. your initial balance is $2000 when you buy at $10, it goes up to $11, and your balance is now $1900? So you lost $100 because the price increased? I think I understand what you are trying to say, but the answer might benefit from a slight cleanup. – Benubird Jun 14 '17 at 15:41
  • I don't understand this answer completely.. could you please clear some points for me Victor? If I don't place a stop loss and the price goes up to $11, I would have made a $1,000 profit and my remaining margin will now be $1,100 (10% of $11,000). So my account balance would now be $2,000 + $1,000 - $1,100 = $1,900. so if I now sell the shares immediately do I still have 1000$ profit? I'm only entitled to $1100 of the selling, right? (final balance after selling: $2000 + $1000) – Dean Jun 14 '17 at 15:54
  • @Benubird Balance and equity are not the same thing. Balance is the cash in your account. Equity is the cash in your account plus or minus the gains or losses from closing all of your currently open positions at their current prices. – David Schwartz Jun 14 '17 at 17:44
  • @Dean - if you close out the trade with $1000 profit, yes your balance will be $3000. But if your trade stays open you have to deduct any remaining margin from the balance. The balance is the amount of funds you have remaining to make any new trades. Your equity is your balance plus any margin, as the margin will be released as soon as you close the trade. – Victor Jun 14 '17 at 20:42
  • @Benubird - I have explained it. I have a note near the top saying that the balance is the amount of funds available to make new trades with. Profits will increase it but any margin will reduce it. And I have represented the calculations in that manner. If you closed out the trade with $1000 profit you would thus have a balance of $3000, as there is no more magin left. – Victor Jun 14 '17 at 20:50

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