In the world of cryptocurrency trading, there are many different trading strategies and approaches. One of the most notable among them is leverage trading.
What is leverage trading? We’ll explore it in this comprehensive guide, along with the risks and benefits associated with this type of trading, how to start trading with leverage, and the key factors to keep in mind.
Introduction to leverage trading
Definition of leverage
Trading with leverage, also known as margin trading, is a popular form of cryptocurrency trading. It essentially means that a trader uses credit provided by a broker to make a transaction.
In simple terms, leverage allows traders to operate with a larger market position than their own investment would normally permit. This enables them to trade with more significant sums, using a smaller amount of their own capital.
What does leverage mean in trading?
Now, let’s break down what does leverage mean. Leverage in trading is the ratio between the trader’s borrowed funds and their own capital. For instance, if a trader is using 1:5 leverage, this means that for every $1 of their own money, they are borrowing $5.
In this way, leverage refers to a specific ratio (the size of the loan compared to the trader’s own capital). The higher the leverage, the greater both the potential profit and loss.
Overview of leverage trading
It’s these high potential risks and rewards that have made leveraged trading so popular in the cryptocurrency world. It began gaining traction in 2017 with the rise of interest in digital assets and the launch of trading platforms like BitMEX, which offered high-leverage trading.
Leverage trading became especially popular during the "crypto boom" of 2020-2021 when platforms like Binance and FTX started offering futures contracts with leverage up to 100x for major assets.
How leverage trading works
Understanding margin and leverage
To engage in leverage trading, a trader needs to provide margin, which is the initial deposit required to open a leveraged position.
For example, if a broker offers 10:1 trading leverage, this means that to control a position worth $10,000, the trader only needs to deposit $1,000 as margin. The remaining amount is provided by the cryptocurrency exchange.
Calculating leverage ratios
The leverage ratio is a key measure that helps traders understand the amount of funds they can control with a certain level of their own capital. But how do you calculate this ratio? There’s a simple formula:
For instance, if a trader opens a position worth $50,000 with $5,000 margin, their leverage is 10:1.
Examples of leverage in trading
Let’s assume a trader uses 5:1 leverage to buy shares. They have $2,000, but with leverage, they can control positions worth $10,000. If the share price rises by 10%, they’ll make a $1,000 profit, despite only having $2,000 of their own capital.
However, if the cryptocurrency price drops by 10%, they’ll lose the same $1,000. It’s important to understand that with financial leverage, losses can exceed your initial investment.
Leverage trading in different markets
Leverage trading in stock markets. In stock markets, leverage allows traders to control larger volumes of shares than they could afford with their own funds. This can be particularly useful for short-term trading strategies, enabling traders to increase profits from small price movements in shares.
Leverage trading in forex. The forex market (foreign exchange market) offers some of the highest levels of leverage across all financial markets. Since currency prices typically show small fluctuations, forex leverage can reach up to 100:1. This makes it attractive to active traders seeking to maximise returns from currency movements.
Leverage trading in cryptocurrency. Cryptocurrency markets are well known for their volatility, making leveraged trading especially risky but potentially rewarding. For instance, exchanges like Binance and FTX offer up to 125:1 leverage for cryptocurrency traders. This means that even small market movements can result in significant profits or losses.
Benefits and risks of leverage trading
Potential benefits of using leverage
The primary advantage of leverage trading is its ability to increase potential profits, even when starting with a relatively small capital. Some key benefits include:
- Increased profits. Leverage allows traders to earn significantly more from small price movements. For example, using 10:1 leverage, a 1% change in asset price can result in a 10% profit on the invested funds.
- Access to larger capital. Leverage enables traders to control larger volumes, which would otherwise be inaccessible. This is particularly useful for traders with limited funds who want to actively participate in the market.
- Efficient use of capital. Leverage allows traders to deploy small amounts of capital to control large positions, freeing up the rest of their funds for other trades or investments.
Common risks associated with leverage
Leverage comes with significant risks. As mentioned earlier, it amplifies both profits and losses. Here are the key risks traders face when things go wrong:
- Increased losses. Leverage magnifies not only profits but also losses. If the market moves against the trader, their losses can exceed their initial investment.
- Margin call. If losses become too high and the margin is insufficient to maintain positions, the broker may demand additional capital. If the trader fails to provide it, the broker may close their positions to minimise further losses.
- Market volatility. Even small price changes can lead to substantial losses with high leverage. Cryptocurrency markets are especially known for their volatility, making leverage trading even more risky.
Risk management strategies
Given the high stakes, traders must prioritise risk management alongside their trading strategies.
- Using stop-loss orders. These orders trigger a sale when the asset's price falls below a set point, limiting potential losses. The exchange will automatically sell the asset if the market price reaches the threshold, acting as a key safeguard.
- Managing position sizes. Traders should carefully compare the size of their positions to their overall capital, ensuring they allocate a reasonable portion to trades. This helps prevent excessive losses from impacting their entire budget.
- Diversifying investments. This strategy involves spreading funds across various assets such as Bitcoin (BTC), Ethereum (ETH), and Toncoin (TON). If one asset decreases in value, gains or stability in other assets can cushion the overall portfolio.
- Keeping track of margin levels. Monitoring the margin ratio, which reflects the relationship between collateral and the value of open positions, is essential to avoid margin calls or forced liquidation of positions.
How to trade crypto with leverage
Choosing the right trading platform
If you’re ready to take on the challenges of trading with leverage, your next step is finding the right platform. With many options available today, making a choice can be tough. Here are some key factors to consider:
- Reputation and trustworthiness. Focus on platforms with a strong track record and positive reputation within the crypto community. Read user reviews and familiarise yourself with the platform's operations. Also, check if it is licensed and complies with regulatory standards.
- Security. Investigate whether the platform has faced hacking incidents or security breaches. Look into its security protocols, such as encryption, registration processes, and user protection measures.
- Trading terms. Review the platform's trading terms carefully. Make sure to research fees, deposit requirements, and the availability of trading pairs in advance.
To help streamline your search, here are a few popular margin trading platforms:
Binance. Offers up to 125x leverage, leading in both trading volume and liquidity. Registration requires verification.
Binance website
Coinbase. Available for Coinbase Pro users, providing leverage of up to 3x.
Coinbase website
Bitget. Offers margin trading along with trading bots and copy trading. Registration involves verification.
Bitget website
Bybit. Allows trading with multiple currency pairs, though margin trading incurs various fees such as spot trading, interest, and position closure fees. Verification is also required for registration.
Bybit website
Setting up a trading account
Once you’ve chosen a platform, you need to create and fund a trading account. Some exchanges require an initial deposit for leverage trading. Additionally, you’ll need to verify your account to access margin trading features.
After your account is set up and funded, choose the leverage level that suits you. This can typically be done directly in the platform’s settings.
Steps to execute a leverage trade in crypto
Now that your account is ready, here are the main steps for executing a leveraged trade:
- Choose an asset. Decide which cryptocurrency you want to trade, such as Bitcoin or Ethereum. Analyse the market to assess potential price movements.
- Set up the order. Enter the trade amount and select the leverage level. Remember, the higher the leverage, the higher the risks. Some platforms also allow you to set stop-loss or take-profit orders for automatic position closures.
- Open the position. After setting all parameters, open your position. You can go "long" if you expect prices to rise or "short" if you anticipate a price decline.
- Monitor and close the position. After opening a position, it's crucial to keep an eye on the market. You can manually close the trade or rely on pre-set parameters like stop-loss or take-profit to automate the process.
Important! This is not financial or investment advice, but simply a selection of some popular trading tips. Itez team does not recommend applying them in practice and does not guarantee that the tips listed here will be profitable. Please remember that we do not bear responsibility for the success or loss of your financial investments.
Key considerations for leveraged trading
Market volatility and its impact
Leverage trading is particularly risky in volatile markets. Cryptocurrencies are known for their extreme price swings, making leveraged trading especially dangerous.
- Sharp price movements. Even small price changes can lead to significant losses when high leverage is involved. For example, with 10:1 leverage, a 1% price movement can result in a 10% gain or loss.
- News impact. Events and news in the cryptocurrency space often cause sudden market reactions. Unpredictable information can lead to price surges or drops, posing heightened risks for those using high leverage.
Traders must recognise that volatility presents both profit opportunities and risk of substantial losses. Being prepared for market fluctuations and adapting to them is key.
Understanding margin calls
A margin call occurs when the broker requests additional funds to maintain a position, as losses have exceeded the initial margin. If the trader fails to provide more capital, the broker may close the position to avoid further losses.
To avoid margin calls, monitor your margin levels and apply sound risk management practices. Using moderate leverage and regularly topping up your account can reduce the chances of a margin call.
Frequently Asked Questions
What is leverage in trading? Leverage allows traders to borrow funds from a broker to control larger positions than their own capital permits. It can increase both potential profits and risks.
How does leverage trading work? In leverage trading, traders deposit a portion of the trade value (margin), while the broker provides the rest. This amplifies both gains and losses depending on market movements.
What are the risks of leveraged trading? Leverage increases the risk of larger losses and margin calls if the market moves against you. Losses can exceed your initial investment.
How can I start trading crypto with leverage? Choose a platform, verify your account, deposit funds, and select your preferred leverage. Then, set your trade parameters and open a position, monitoring the market closely.
Conclusion
Leverage trading allows traders to control larger positions with borrowed funds, amplifying both profit and loss. It’s particularly risky in volatile markets like cryptocurrency, but with the right approach, it can be highly rewarding. Choosing a reliable platform and understanding margin are crucial steps to getting started.
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This article is not investment advice or a recommendation to purchase any specific product or service. The financial transactions mentioned in the article are not a guide to action. It’s not intended to constitute a comprehensive statement of all possible risks. You should independently conduct an analysis on the basis of which it will be possible to draw conclusions and make decisions about making any operations with cryptocurrency.
