Futures trading is a unique discipline. There are no time clocks to punch, 401ks, or employee health insurance policies ― your success depends upon how well you use all available resources. Simple as that.
Trading leverage is a big part of maximizing your financial potential as a trader. If you’re seeking massive returns, then the flexibility of futures may be an opportunity you can’t afford to miss.
Leverage Is Truly a Double-Edged Sword
Virtually all trading literature warns against the perils of leverage, and rightfully so. Losing a large amount of money can be an incredibly negative experience that affects a person’s financial well-being and physical health.
However, there’s an upside to leverage ― traders can use it to produce extraordinary gains. In futures, trading leverage is an essential part of the business and a primary reason that people from around the globe enter the marketplace.
As a derivative product, futures contracts offer traders a unique application of financial leverage. In fact, they feature several characteristics not found anywhere else in the capital markets:
- Low capital requirements: Reduced margins augment purchasing power and are a premier benefit of the futures markets. Margin requirements may be as low as 5%, a fraction of the 50% required by stocks.
- Liquidity: Traders can quickly and inexpensively convert futures to cash. This feature differs greatly from such hard assets such as real estate, essentially freeing up capital for immediate reinvestment.
- Flexibility: A trader can take long or short positions in the markets of equities indices, currencies, debt, or commodities. The inherent flexibility of futures furnishes individuals with the ability to leverage risk capital in a vast number of ways.
There simply aren’t many venues where a market participant is able to put up a small amount of capital, control a large quantity of a valuable assets, and enjoy maximum liquidity. Due to these attributes, the application of leverage via futures trading is a viable way of realizing large profits.
3 Ways Trading Leverage Enhances Gains
Traders can apply futures leverage in almost infinite ways, limited only by the imagination of the individual. However, no matter which approach you take, responsible money management is a prerequisite to enjoying any of benefits leverage may provide.
Any trades are educational examples only. They do not include commissions and fees.
Here are three ways that the trading leverage of futures can bolster returns:
- Position sizing: The ease of increasing position size in futures is superior to more conventional investment vehicles. Lower margin requirements allow for enhanced buying power, making it easy to add exposure to long or short positions. Subsequently, the profits from beneficial moves in pricing are increased. For example, Avery the energy trader has a strong bearish bias toward the WTI crude oil market. Being already short one lot of WTI crude oil, Avery decides to sell three more at market, effectively increasing the trade’s per tick exposure to $40. For every cent WTI crude oil falls, Avery’s profitability is now $40 compared to the original $10.
- Strategic freedom: When trading more than one lot, the added leverage opens the door to a vast number of strategic options. From exiting the market at multiple profit targets to combining scalp and trend strategies, the added trading leverage can enhance gains exponentially. Let’s assume that Avery’s bias has proven correct and WTI crude oil has quickly fallen by 25 cents from average entry. The position is already in the green by $1000, a tidy profit. However, Avery sees no reason to exit the position, expecting more downside in WTI’s immediate future. The added leverage gives Avery the freedom to take off a few contracts and rack profits while holding the others for larger gains. In effect, the potential rewards from the trade can be huge in comparison to the assumed risk.
- Advanced return on capital (ROC): The leverage available in futures allow for trading accounts to control asset values far in excess of deposits. Due to this fact, returns on positions can be extensive and rapid. This increases the probability of significantly compounding ROC without having to spend years or committing additional funds doing so.
Understanding the Ins and Outs of Leverage
Perhaps the most important thing to know about trading leverage is that it magnifies the intensity of both wins and losses. When things go well, leverage is a trader’s best friend. When they go poorly, the implications can be devastating.