RJO Futures Tip of the Week - Leverage in the Futures Market, the Power of Gold Futures

How many of you remember the Periodic Table Grid? The Periodic Table Grid takes me back to my sixth grade science class discussion about gold. Of course, I would need to do a little refresher on what the table means, but one thing I can still recall the symbol used for gold on the grid, AU. Everything else is a blur since it was so long ago. Before I give you a brief recap on what some of you learned many years ago I would like to point out that gold has remained one of the most important commodities in the world. It has been dubbed as the “flight to quality” safe haven investment. In other words, as we experience political unrest around the world or lack of confidence in the value of other currencies, gold is viewed as a safe haven for many investors.

Our “RJO Tip of the Week” will focus on the value of leverage using gold futures in this example. To fully understand the value of leverage, you must understand the full cash value of the contract that you are trading as well as the margin requirement for holding a position.

Step 1: Calculate the Full Cash Value

Gold futures are a standardized contract weighted in ounces traded at the CME Group and the NYSE Liffe US exchanges. It is easy to calculate the full cash value by multiplying the price of the contract by the ounces of gold outlined in the contract specs. For example, if gold is trading at $1,677.50, the full cash value for the 100 oz. contract is $167,750.

Step 2: Margin Requirements

The initial margin for one 100 oz. gold contract is $11,475. The margins are set by the exchange based on market volatility and average daily price movements. The exchange has the right to change margins at any time based on market actions which does apply to any open positions that you may be holding. Therefore, we recommend maintaining more than exchange margin requirements in your account when trading.

Margin Requirements:

Step 3: The Power of Leverage

The percentage of funds required to hold a contract of gold relative to the full cash value of the underlying contract is your power of leverage. For example, you can hold 100 oz. of gold worth $167,750 for only $11,475 which is approximately 7% of the full cash value of the underlying contract. The same ratio of leverage applies to all gold contracts. The power of leverage enables investors to participate in a market with less capital up front. However, it is important to note that many individual traders use more than 80% of their account value towards margins whereas professional money managers typically use 3 – 20% of their total capital towards trading. This is one of the reasons that retail traders are at a higher risk of losing more than they initially invest than professional traders.

I mentioned in the beginning of this article that I would give you a quick refresher on what I learned about gold years ago. Gold is a chemical element, it is known as AU on the periodic table. When I was in 6^th grade, gold was trading under $400 oz; it has rallied a whopping 418% since. Some of the common uses for gold are in computers, glasses, jewelry, dentistry and electronics. The chart below gives you a visual of how gold has dramatically increased in value over the years. Therefore, increasing in leverage….