Financial leverage is the use of debt to secure additional assets. Businesses and individuals both implement leverage. For example, if you have a car loan or a mortgage, then you’re already using leverage.
In many ways, leverage is the backbone of the global derivatives markets. Market participants depend on the extension of credit to buy and sell financial instruments via the mechanism of margin trading. Although there are certainly very real dangers to leverage, the potential upside often outweighs the assumed risk.
Benefits of Trading Leverage in Futures
When it comes to active trading, leverage is the extent by which you use your capital resources to buy and sell financial instruments on margin. The availability of margin is a key element of trading leverage, and the degree and application vary from market to market, broker to broker.
In practice, your ability to leverage capital in traditional equity products is much less than in futures. Securities and Exchange Commission (SEC) requirements define margin as being a minimum of 50% of the aggregate position value. Conversely, futures margins are vastly reduced at 3% to 12%. This significant difference frees up active future traders to take positions in multiple markets well in excess of their available capital resources.
The extensive leverage local to futures products offers active traders several advantages:
- Boosts buying power: Minimal risk capital may be used to control much larger positions in the open market.
- Allows for diversification: All major asset classes are included, from equities to livestock.
- Enhances returns: The larger the assumed leverage, the greater the potential returns.
Leverage is the ultimate double-edged sword. However, without its presence in the derivatives trade, high barriers to entry would limit participation to only those with an extremely large net worth.
3 Advantages of Trading the E-minis
If you’re going to participate in the futures markets, then you’re going to be trading leverage. No matter the product ― E-minis or otherwise ― the extension of credit by a broker facilitates trade. In return, a preset fee and commission structure act as compensation for the broker’s services. This client-broker relationship ensures that trading activities may proceed unencumbered and that the necessary resources for margin trading are available.
In comparison to full-sized futures contracts, the E-minis offer three essential benefits to parties interested in trading leverage:
- Reduced margins: E-mini products provide traders reduced day-trade and maintenance margins relative to full-sized futures. For instance, equities index products — such as the E-mini S&P 500, E-mini DOW, and E-mini NASDAQ — offer day-trade margins for as little as $500 per contract.
- Diversification options: E-minis come in many forms, representing a wide variety of asset classes. Currencies, equities, and commodities may be incorporated into any trading plan. As a result, it’s possible to either hedge risk, pursue speculative opportunities, or do both.
- Capital allocations: In many cases, E-mini futures require a much smaller financial commitment than their asset class or full-sized counterpart. As an example, E-mini DOW futures provide traders with a way to engage the DJIA without buying shares of all 30 member companies. With a minimum tick value of $5.00, the E-mini DOW also lets traders participate in the market without tying up huge chunks of risk capital.
Debt and credit often carry negative connotations. However, when it comes to futures, trading leverage is an essential part of the industry. Although using leverage may be hazardous to your financial wellbeing, it also makes futures trading possible while promoting efficient markets.
Getting Started with the E-minis
The E-mini lineup of futures products is a great way to enjoy the benefits of trading leverage without tying up a majority of your risk capital. For more information on the E-minis, check out the online educational suite available at Daniels Trading. Featuring expert market analysis, webinars, and guides, it provides valuable resources to aspiring and active E-mini traders.