Leverage, Risk And Margin Calls

Leverage increases the ability of a person’s dollar to make or lose money. Leverage allows a trader to use less money to place a trade, potentially increasing either the risk or the return of investment (ROI) per dollar invested. One 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, there is a profit of $50 on the $100 investment or a 50 percent (ROI). Having leverage is putting up $50 to buy something worth $100. When it becomes worth $150, the profit is still $50, but it was made using only $50, which is a 100 percent ROI.

There are two types of leverage: Leverage with uncapped risk and leverage with capped risk.

Leverage with Uncapped Risk
If someone puts up $50 to buy something, that has a value of $100 but it becomes worth $0, then not only is the $50 invested lost, but another $50 would also be lost. If the additional $50 is not in the trader’s account, a margin call would be received from the broker saying that more money must be sent immediately.

Leverage with Capped Risk
It is the same scenario as above, but only the $50 initially invested would be lost. The trader would not lose the entire $100 the instrument was worth. This is because the risk is capped to the amount of money originally had put up. The benefit of capped risk is only $50 of the value in the $100 instrument is at risk.

Margin Calls
When a margin call is received informing a trader of lost money, one of three things will happen:

1. Automatically close the trade.
2. Note: The broker is not required to automatically close the trade.
3. If the market moves fast or between open and close, they may not have time to close it.
4. The trader could lose more than the total amount in the trading account, including margin.
5. Call to inform the trader that additional funds or collateral such as bonds, stocks or cash must be deposited usually the same day, or the position must be closed.
6. Allow the trader to close part or all of the position or any other positions to free up capital.
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8. 100 Percent Defined Limited Risk
9. Having capped risk means that the required margin or the capital required to enter the trade is the maximum risk. A trader may have $2000 in the trading account and put up $300 for 10 Nadex Gold futures spread contracts valued at $157,000 in buying power. The trader is risking only 15 percent of the account. Using Nadex Spreads, risk is limited with more time to be right about the direction the market will move. If the market gaps with a fast move down 30 points, the trader will have lost $300, but that is the maximum loss. There will be no margin call. In addition, profits can potentially still be made until expiration, in case the market bounces back.
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