Leveraged trading refers to having control over a financial instrument, in this example, a commodity futures contract, with a large cash value with a relatively small initial investment.
An investor has control over the full contract value, even though he/she does not invest 100% of the contracts full value.
In order to have control over a commodity, an investor must invest an initial margin, which is typically around 5% of the contracts overall value.
Controlling 100% of a commodity with only a 5% investment can produce large profits as well as large losses and this fact is most easily explained with an example.
At the time of this writing, in the Gold market you are able to control one contract, 100 ounces, valued at $110,780.
00, for an initial margin investment of $5,403.
00.
The 100 oz.
Gold contract has a minimum price fluctuation, also known as a "tick", of $0.
10 with a tick valued at $10.
00.
If you had a long position in Gold, a full $3.
00 (three dollar) move in Gold prices from $1107.
00 to $1110.
00 would produce a $300.
00 profit to the investor.
On the other hand, holding the same long position in Gold, a $3.
00 move from $1107.
00 to $1104.
00 would produce a $300.
00 loss.
It is important to understand the arithmetic of leveraged trading before you consider entering the commodity markets as an investor.
Understanding leveraged trading can give a trader a large advantage of capitalizing on their relatively small investment.
On the other hand, diving into leveraged trading without fully understanding the risks involved or a proper education can expose you to large, unexpected losses.
There is a substantial risk of loss involved in futures trading AND IS NOT SUITABLE FOR ALL INVESTORS.