Sergey Golubev / Profil

Understanding Leverage (source - dailyfx)

The difference between trading stocks and futures is the amount of capital required to enter a trade. While this could be a very long and detailed section with examples of leverage, I am going to keep things simple and short cause it’s really not that difficult.

Using an example of a trader which we will say his name is “Dave” who wants to trade the SP500 index with their risk capital here are two examples that show how leverage drastically changed the outcome of a position.

Dave has a $10,000 account, and wants to swing trade the SP500 index.
Option #1: He buys $5000 worth of the SP500 ETF (SPY). And if the SP500 rises in value by 3% Dave would see a $150 gain on his trade. This ETF has no leverage and follows the performance of the stock market.
Option #2: Dave decides to buy 1 ES mini futures contract which is the SP500 Index futures contract. Using the same numbers as the previous option, the SP500 rises in value just 3%. How much money did Dave make on this trade? He made a whopping $2,625 on the same move that the ETF did, how is that possible?
Let me explain, when you buy a non-leveraged ETF like the SPY with $5000, you are literally only trading with a $5000 investment. But with futures, when you buy one ES mini contract which is worth roughly $5000, you are actually controlling roughly $75,000. So think if it as 17.5x leverage on your money.
So that 3% gain in the stock market is based off a $75,000 investment which is how you get $2625 or a 52.5% return on your money.

Futures trading in my opinion is not for beginner or intermediate traders. The only way your money should be involved with futures is if you truly understand how the market move and have strict money management rules, or us a system that trades and managed positions for you. Remember, leverage is a double edge sword that can make you wealthy or broke quickly if not traded appropriately.

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