Notional versus margin, and effective leverage
Lesson 10 · about 9 min
The risk course introduced notional and margin in one lesson. This one goes further, because in futures the gap between the two is the entire source of both the opportunity and the danger, and the word "leverage" gets used in three different ways that give three different numbers.
Three leverages
Maximum leverage is what the margin allows: notional ÷ margin. It is a property of the contract and the broker, not of your trading.
Account leverage is notional ÷ account equity. It measures how big your position is relative to everything you have.
Effective leverage in the risk course's sense is the ratio between a percentage move in the underlying and the percentage change in your equity. For a single futures position it equals account leverage. This is the one that decides how fast you can lose.
| Situation | Notional | Margin posted | Account equity | Max leverage | Account leverage |
|---|---|---|---|---|---|
| 1 ES on day-trade margin, $5,000 account | $250,000 | $500 | $5,000 | 500× | 50× |
| 1 ES on initial margin, $16,000 account | $250,000 | $16,000 | $16,000 | 15.6× | 15.6× |
| 1 MES on day-trade margin, $5,000 account | $25,000 | $50 | $5,000 | 500× | 5× |
| 3 MES on initial margin, $25,000 account | $75,000 | $4,800 | $25,000 | 15.6× | 3× |
| 1 MES, $50,000 account | $25,000 | $1,600 | $50,000 | 15.6× | 0.5× |
Two of those rows have the same maximum leverage (500×) and completely different account leverage (50× versus 5×). The margin number is the same; the risk is ten times different. This is why max leverage is nearly useless as a risk measure. What matters is account leverage, and the only way to change it is to change the notional you hold relative to your equity.
What account leverage does to a move
At account leverage L, a move of x% in the underlying changes your equity by L × x%.
| Account leverage | 0.5% move | 1% move | 2% move | 4% move |
|---|---|---|---|---|
| 0.5× | 0.25% | 0.5% | 1% | 2% |
| 3× | 1.5% | 3% | 6% | 12% |
| 5× | 2.5% | 5% | 10% | 20% |
| 15.6× | 7.8% | 15.6% | 31% | 62% |
| 50× | 25% | 50% | 100% | wiped out |
At 50× account leverage, a 2% adverse move in the S&P 500, which happens several times in a typical year, takes 100% of the account. At 5×, the same move costs 10%, painful but survivable. At 0.5×, it costs 1%, which is what a well-sized trade looks like.
Where this leaves margin
Margin's job is to protect the clearing house and your broker. Your job is to protect your account. The two numbers that do those jobs are unrelated:
- The broker needs your margin to be covered, which it usually is by a wide margin on any sensibly sized position.
- You need your stop-loss in dollars to be a small fraction of your account, which margin says nothing about.
A useful discipline is to size every trade from the stop first (Module 2, Lesson 4), then compute account leverage as a check:
account leverage = (contracts × notional per contract) ÷ equity
If the answer is above something like 5× for a day trade or 2× to 3× for an overnight hold, the position is large relative to the account even if the stop is tight, because a gap through the stop will cost far more than planned. Module 5 covers gaps.
Key idea: There are three leverages. Maximum leverage (notional ÷ margin) is set by the broker and tells you nothing. Account leverage (notional ÷ equity) tells you what a 1% move costs you. Size from the stop, then check account leverage as a ceiling.
Worked example: the same trade at three account sizes
One MES at 5,000, a 10-point stop ($50 risk), held intraday on $50 day-trade margin.
| Account | Risk as % of equity | Account leverage | 2% adverse gap cost | Gap as % of equity |
|---|---|---|---|---|
| $2,000 | 2.5% | 12.5× | $500 | 25% |
| $5,000 | 1% | 5× | $500 | 10% |
| $25,000 | 0.2% | 1× | $500 | 2% |
The stop risk in the $2,000 row is 2.5%, which is already over the 1% guideline, but the real problem is the last column: if the market gaps 2% through the stop, that account loses a quarter of itself on one micro contract. The $25,000 account with the same position is comfortable in both columns. Margin permitted all three accounts to hold the contract. Only one of them should.
Overnight changes everything
Intraday, your stop is live and the market is continuous, so the dollar risk is roughly stop distance plus slippage. Overnight and over weekends, the market can reopen far from where it closed and the stop fills at the reopen. Account leverage is the number that tells you how bad that can be, which is why the guideline for held positions is much lower than for intraday ones. Module 5, Lesson 1 works the numbers.
Try it: For your current or intended account size, compute the account leverage of holding 1, 2 and 5 MES, and 1 ES. Then compute what a 3% adverse overnight gap would cost in each case as a percentage of equity. Decide, in writing, the maximum account leverage you will allow intraday and overnight.
Recap
- Maximum leverage = notional ÷ margin; it is a broker property and says nothing about your risk.
- Account leverage = notional ÷ equity; a move of x% in the underlying changes equity by account leverage × x%.
- At 50× account leverage a routine 2% move wipes the account; at 5× it costs 10%.
- Size from the stop first, then check account leverage as a ceiling: low single digits intraday, lower overnight.
- Overnight and weekend gaps fill your stop at the reopen, so account leverage, not stop distance, sets the worst case.