Spread betting and CFD trading is a form of leveraged trading. Leveraged trading gives you the opportunity to earn back the amount that you trade many times over, or conversely to lose the amount that you have traded many times over. It is sometimes known as marginal trading, or occasionally gearing, and this last term gives a bit of a clue as to how leveraged trading works.

The theory is not dissimilar to the gears on a car, the power from the engine is maintained but as you change up through the gears, the same power can turn the wheels faster. When it comes to your money, then, the leverage allows you to increase your winning (and losing) potential.

The leverage is basically ‘borrowing’ money to add to your investments, and you borrow from a company, such as CMC Markets, who specialise in spread betting. One of the advantages of spread betting is that it is not subject to Capital Gains Tax, and therefore you get to keep more of the money that you own. So how does it work? If we briefly consider ‘normal’ trading on the stock market; you decide to invest a certain amount in some shares in the hope that their value will rise and you can pocket the difference when you sell them. If the share price rises by 10% then you make 10% profit on your original investment, if the shares lose value by 10% that is how much you lose.

Leveraged trading allows you to multiply these winnings (and losses). The intermediary adds more money, for example, so that you can buy ten times as many shares as you would originally have done. Therefore if the share price goes up 10%, you will get 100% profit on your investment, doubling your money, of course if the share price drops by the same amount you will lose 100% of your invested money.

When it comes to spread betting the mechanics are slightly different. You trade a certain amount on whether the stock market will move in a certain direction, and if you are right through the leveraging system you regain your original stake multiplied by how many points the market moves, if you are wrong you lose your original stake multiplied by how many points the market moves and that is why leveraged trading can be so dangerous.

Most spread betting companies are keen to point out the risks of leveraged trading, and the best way to minimise those risks is to make sure that you pick a certain market and get to know the ins and outs of it. With the current economic situation starting to trade is particularly difficult, but it might just be a good time to do some research and make sure that when things stabilise, you know what you are doing and are in a position to capitalise.