If you are bearish on gold, you can profit from a fall in gold price by taking up a short position in the gold futures market. You can do so by selling (shorting) one or more gold futures contracts at a futures exchange.
You decide to go short one near-month NYMEX Gold Futures contract at the price of USD 851.00/oz. Since each Gold futures contract represents 100 troy ounces of gold, the value of the contract is USD 85,100. To enter the short futures position, you have to put up an initial margin of USD 4,302.
A week later, the price of gold falls and correspondingly, the price of NYMEX Gold futures drops to USD 765.90 per troy ounce. Each contract is now worth only USD 76,590. So by closing out your futures position now, you can exit your short position in Gold Futures with a profit of USD 8,510.
|Short Gold Futures Strategy: Sell HIGH, Buy LOW|
|SELL 100 troy ounces of gold at USD 851.00/oz||USD 85,100|
|BUY 100 troy ounces of gold at USD 765.90/oz||USD 76,590|
|Investment (Initial Margin)||USD 4,302|
|Return on Investment||198%|
In the examples shown above, although gold prices have moved by only 10%, the ROI generated is 0%. This leverage is made possible by the relatively low margin (approximately 5%) required to control a large amount of gold represented by each contract.
Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.
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