Should You Buy Shares With Leverage?

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Okay, this week I’ve got a challenge for you.

I’m going to give you a piece of hypothetical information. I then want you to see how much money you make from it. This will really put your understanding of risk to the test.

So here we go…

Now, suppose you knew that the price of gold would rise 90% over the next three years. This isn’t speculation, it’s a sure thing. You have 100% certainty that gold will nearly double in value.

So how would you use this information to make the most money possible?

Now, there are many ways you could trade this knowledge. But I’ll narrow it down to two choices:

1. You could buy gold outright; or
2. You could use a CFDs to get leverage.

Before you decide, have a look at this: Okay, so this is a real chart of the gold price from an earlier time. But for today, I want you to imagine it’s showing you the future. Don’t worry about the big chunk of data missing. I’ll tell you why I’ve covered it up in a minute.

Now, suppose you can buy gold at $1,000 (where I’ve marked on the chart). And you know you can sell it for $1,900 in December 2021.

So how much would you buy? Remember, there are two options:

1. Buy gold outright; or
2. Use a CFD to get leverage.

To give you an idea, one CFD provider has a product that will give you leverage of 100 to 1. This means for every dollar gold moves, your account’s value changes by $100.

For instance, if you buy one CFD when gold is $1,000, and sell when it’s at $1,900, you’ll pocket $90,000. That’s the power of leverage.

Now, think for a moment. The price rise is a certainty. Do you play it safe, or do you leverage up with CFDs?

Just for fun, work out a hypothetical trade. Use your capital base to decide how much gold, or how many CFDs, you’d buy. It will be interesting to see how this plays out for you.

Okay, so let’s fast forward three years.

Check this out: There’s no surprise with the result — gold hits $1,900 bang on schedule. If you’d bought the yellow metal outright, your account is up a healthy 90%.

But what if you chose the CFDs?

Well, you’re potentially up $90,000 per contract. It doesn’t take much maths to calculate some pretty big numbers. You could be ahead by over a million dollars with just a dozen CFDs.

There’s just one question: Were you able to hang on?

Yes, you knew gold would hit $1,900 — that was never in doubt. The only problem was, you didn’t know what course it would take. Look at the decline following the entry point. Gold falls by over $300 per ounce.

Now, this isn’t an issue if you bought gold with capital sitting in your account. You knew the fall was only temporary. All you had to do was ride it out, and wait to collect.

But it’s not so simple if you’re using leverage. You see, the CFD provider adjusts your account daily. It adds money when the price rises, and makes withdrawals when it falls.

Do you remember the amount of leverage on the gold CFD?

Well let me remind you — it’s 100 to 1. So for every dollar gold falls, you lose $100 from your account. In our example, gold falls by $319. Multiply that by 100 and you get a loss of $31,900. And that’s for just one CFD. How many contracts did you think of buying?

The CFD provider will allow you to keep the trade as long as you can cover the loss. If your account runs out of funds, it’s all over. The trade gets closed. All you get to keep is the loss.

Even knowing the future doesn’t guarantee a profit when using leverage. The simple fact is this: You can be the world’s best trader and have a heap of capital. But you still run the risk of ruin if you use too much leverage.

So that’s all for this week. If you liked this video, or even if you didn’t, scroll down and leave me a comment, or maybe a thumbs up. Also, if you’re watching this anywhere other than my website then head over and have a look.

So until next time, I’m Jason McIntosh, and let’s find some trends this week.

Meet Jason

I'm Jason McIntosh, the creator of Motion Trader. My career began in 1991 on the trading floor at Bankers Trust. Nowadays, I trade my own systems from home in Sydney. 
Motion Trader is for investors who value robust analysis, data driven entry and exit signals, commentary, and education. I use engineered algorithms to identify when to buy and sell ASX stocks. No biases or guesswork, just data driven signals.