how to understand leverage
WHAT IS LEVERAGE?
When it comes to futures trading, the use of leverage is quite normal. Leverage if used correctly and properly will be a very powerful tool. However if used wrongly it can destroy your trading account in no time. Before we start using leverage, we first need to understand what leverage is.
Leverage is an investment/trading strategy that uses borrowed capital in order to increase profit potential of a trade and an investment. The collateral for this borrowed capital is the money you have put in. The use of leverage will multiply your potential trades profit by a certain factor. For example, you have USD 1 million starting capital. You then seek to borrow another USD 2 million. So you now have in effect USD 3 million thus leverage factor of 3. Profit potentials are multiplied by 3.
Leverage: Good and Bad
Investors and traders alike use leverage to significantly increase the potential returns of their trades/investments. The reverse is also true. Leverage will also increase the potential loss of a trade. It is a double-edged sword. By using leverage and prices moving against their trades, then potential loss is much greater than if traders had not used leverage.
Comparison: Leverage and Non-leverage
|Buy 100oz of Gold at USD 1,300 / oz||Paid USD 130,000||Paid USD 13,000|
|Gold price rose to USD 1,400 / oz||Profit USD 10,000||Profit USD 10,000|
|Gold price fell to USD 1,200 / oz||Loss USD 10,000||Loss USD 10,000|
|Need to top-up USD 10,000|
|Total deposits USD 23,000|
|Gold price fell to USD 800 / oz||Loss USD 50,000||Loss USD 50,000|
|Need to top-up USD 50,000|
|Total deposits USD 63,000|
Margin trading & margin requirements
Your deposited money will be used as a collateral for the transactions. This collateral is called margin requirements. To keep holding their positions, traders need to maintain the margin required. Agrodana Futures provide a 100:1 leverage for forex trading. Contract size per lot traded is 100,000 units for regular account.
What this means is that with as little as USD 1,000, trader can take BUY/SELL position 100x greater. For example, trader buy 1 lot of EURUSD pair at 1.1300. The margin required for this trade is USD 1,000 but the trade size is 100,000 units x USD 1.1300, or equal to USD 113,000. So with just USD 1,000 he/she can trade up to USD 113,000 in this example