By Darrell Martin
Leverage increases the ability of your dollar to make or lose money. Leverage allows you to use less money to place a trade potentially increasing either the risk or the return of investment (ROI) per dollar invested. You can do more with less.
An example of not having leverage is putting up $100 to buy something that is priced at $100. If it becomes worth $150, you have made $50 on your $100 investment or a 50 percent (ROI). Having leverage is putting up $50 to buy something worth $100. When it becomes worth $150, you still make $50, but you made it using only $50, which is a 100 percent ROI.
There are two types of leverage: Leverage with uncapped risk and leverage with capped risk. Let’s compare these two types.
Leverage with Uncapped Risk
If you put up $50 to buy something that has a value of $100 but it becomes worth $0, then you would not only lose the $50 invested, but you would lose another $50. If you don’t have the additional $50 in your account, you would receive a margin call from your broker telling you to send the needed money immediately.
Leverage with Capped Risk
It is the same scenario as above, but you would only lose the $50 initially invested. You would not lose the entire $100 the instrument was worth. This is because your risk is capped to the amount of money you had put up. The benefit of capped risk is only $50 of the value in the $100 instrument is at risk.
Which type of leverage do you want when trading?
Margin Calls
When you receive a margin call informing you that you have lost money, one of three things will happen:
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Automatically close your trade.
a. Note: The broker is not required to automatically close your trade.
b. If the market moves fast or between open and close, they may not have time to close it
c. You could lose more than the total amount in your account, including margin.
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Call to inform you that additional funds or collateral such as bonds, stocks or cash must be deposited usually the same day, or the position must be closed.
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Allow you to close part or all of the position or other positions you may have to free up capital.
100% Defined Limited Risk
Having capped risk means that the required margin or the capital you must put up to enter the trade is the maximum risk. You may have $2000 in your account and put up $300 for 10 Nadex Gold futures spread contracts valued at $157,000 in buying power. You are risking only 15 percent of your account. Through the use of Nadex Spreads, you can limit your risk and have more time to be right about the direction the market will move. If the market gaps with a fast move down 30 points, you will have lost $300, but that is your maximum loss. You will not receive a margin call. In addition, you have until expiration for the market to come back, so you can potentially still make a profit.
To increase your understanding of trading Nadex binary options and spreads as well as futures forex and CFDs, visit www.apexinvesting.com, a service of Darrell Martin.