Leverage is not a bad word
The scientific defination of leverage is the use of a smaller energy force to move an object of a greater energy force. Since the age of cavemen, the use of leverage in the form of simple tools has made the lives of mankind much easier.
Yet, in the financial markets, leverage is associated with high risk and investors often shunned leveraged products. The recent volatility in the markets also had many investors pointing their fingers at leveraged traders cutting losses to meet margin calls.
Indeed it is true that leverage trading carries a certain level of risk. With the investor only putting up a percentage of the total contract value, he runs the risk of losing his entire investment and more. For example, to trade 1 lot of Emini S&P at price 800, the contract value is Usd40,000 (usd50 x800pts), but the investor only has to have Usd 5000 to initiate a position. If the contracts falls by 100pts, the contract value drops by 12.5%, but the investors loses 100% of the amount he invested.
But to avoid the use of leverage is like not using fire to cook for the fear of burning your house down. The use of leverage in futures trading carries no financiang cost. The investor can use a small amount of deposit to trade a larger contract size, thus increasing his wealth exponentially. In the above scenario, the investor will be able to double his investment on a 12.5% increase in the contract value. If not for the use of leverage, he would have to save up to Usd40,000 before being able to trade. Or if he had chose trade using his exiting Usd5000, say 10 lots of ABC share at $5 each, the shares will have to double to $10 for a 100% return.
Therefore, for normal investors, leverage in futures trading offers a fast and cost effective way to increase wealth. The question is not whether to use it or not, but how to use it to your advantage.
