Part 2 of 4
NEW YORK (TheGoldAndOilGuy.com) -- Mistake # 2 -- Using Too Much Leverage
With this section talking about leverage I am mainly going to be referring to futures trading because futures provides the most leverage. Anytime I talk about futures trading with someone, more times than not they either say they do not trade those things or they tune out all together because in their mind it's crazy and risky.
While there is no question that futures can be volatile at times, what individuals do not understand is that it's not the volatility of the market that causes problems. It's proven that most large-cap, big-name stocks actually have more volatility than the majority of futures contract, whether it's the S&P 500, wheat, corn, gold, oil, etc. The problem is the amount of leverage one used with their money.
The difference between trading stocks and futures is the amount of capital required to enter a trade. While this could be a very long and detailed section with examples of leverage, I am going to keep things simple and short cause it's really not that difficult.
Using an example of a trader, "Dave," who wants to trade the S&P 500 index with his risk capital, here are two examples that show how leverage drastically changed the outcome of a position.
Dave has a $10,000 account and wants to swing trade the S&P 500 index.
Option #1: He buys $5,000 worth of the SPDR S&P 500 ETF Trust (SPY). If the S&P 500 rises in value by 3%, Dave would see a $150 gain on his trade. This ETF has no leverage and follows the performance of the stock market.