How to calculate futures market leverage?
To calculate the leverage of the futures market, it is enough to divide the value of the contract by the amount of the initial guarantee of the contracts.
In the above example, the leverage of saffron futures market is equal to:
According to the example above, Mr. Ahmadi can invest 8,000,000 Tomans with only 1,800,000 Tomans; That means his profit and loss will be 4.44 times compared to the amount of 1,800,000 Tomans.
Tip
1. Due to the fact that the guarantee amount and the value of the contract are variable, therefore, the financial leverage does not have a fixed amount and may change at any moment.
2. The amount of financial leverage is not recorded anywhere (online system or contract specifications) and traders must calculate it based on the above formula.
A misconception about leverage
Some traders’ idea of financial leverage is that when they profit from the difference in buying and selling prices in the futures market, that amount of profit is multiplied by the financial leverage, while this idea is not correct. In fact, leverage shows the amount of investment per percentage change in price.
To clarify the issue, consider the following example:
Mr. Ahmadi takes a position to buy pistachios at a price of 100 thousand tomans. Then by taking a sell position at the price of 105 thousand tomans, he offsets his position. His profit from this transaction is as follows:
Profit = (selling price – buying price) x contract size
500,000=(105,000-100,000)×100
Mr. Ahmadi’s profit is equal to 500 thousand tomans.
Some traders think that this 500,000 Tomans should be multiplied by financial leverage; But the leverage lies in the amount of investment and the resulting profit.
Assuming that the guarantee is equal to 1 million Tomans. Mr. Ahmadi earned a profit equal to 500 thousand tomans with 1 million tomans capital; That is, with a 5% increase in the price, Mr. Ahmadi made a 50% profit compared to an investment of 1 million. In fact, for every percent increase in price, the investor gets 10 times the profit. In this example, financial leverage is equal to 10.
Is leverage in financial markets good or bad?
Due to the fact that despite the leverage, the profit or loss multiplies for a certain amount of investment, so leverage will be very useful for the trader in a situation where he is in profit. In a situation where the trader is in loss, reverse leverage works and increases his loss. In fact, leverage is like a double-edged sword. It should be noted that investors enter any market hoping for profit and make transactions. As a result, they think their transactions will be profitable. Thus, the high leverage in the futures market makes it more attractive to investors.
last word
Although the presence of higher leverage adds to the attractiveness of the futures market; However, considering the risk of futures trading, novice traders can start with contracts with lower leverage and reduce their risk.
Mehdi Koh Soltani (financial services, accounting, financial and tax consultant):
Link to the audit accounting clinic
https://t.me/joinchat/BnzBsTuioTshiXBwf9bBPQ