Key Takeaways
- Leverage trading in crypto enables you to increase your potential returns by borrowing funds from an exchange or a broker.
- The level of profit or risk you can expect will be proportional to the amount of funds you borrow.
- You can use leverage in crypto during any time frame.
- While leverage trading allows you to multiply your profitability, it also increases the possibility of losing your entire deposit.
According to the legendary ancient Greek physicist Archimedes, you can move the entire earth with a firm spot to stand on. For crypto investors, “leverage trading” can be the firm spot. As long as that spot is strong enough, it can act as a lever with which you can move “mountains.” There’s no doubt that crypto leverage trading has many benefits – you must grasp this concept before dipping your toes in its chirpy waters.
While numerous arguments surround crypto leverage trading, several crypto exchanges still offer it to traders. This guide aims to add value to your crypto investment decision-making by dissecting the double-edged crypto leverage trading by explaining how it works, its advantages and disadvantages, and how you can mitigate its risks.
Introduction to Crypto Leverage Trading
Leverage trading in crypto is a promising but high-risk trading technique with an outsized influence. The practice was around even before the advent of cryptocurrencies. It is comparable to how businesses borrow production capital to boost their return on investment (ROI) when they see an opportunity but lack sufficient resources. The method involves borrowing funds from a crypto exchange to increase your purchasing power to buy or sell cryptocurrencies and increase your chances for a more significant ROI.
If you’re trading crypto but have a small initial capital, leverage trading multiplies your buying or selling power by making your capital collateral for leveraged trades. However, since leveraging uses borrowed money (debt) to do crypto trading, it involves a degree of risk, especially if the trade fails to perform as planned or expected.
This makes the innovative concept attractive but challenging, especially for newbies dealing with speculative and volatile assets like cryptocurrencies. However, when done correctly and luck is on your side, the rewards can be lucrative, even when liquidation risks always overshadow them. The most important things to remember are:
- Leverage trading involves using borrowed funds for trading to make more significant profits
- The higher the leverage, the greater the profits and the higher the risks
How Does Leverage Trading Work in Bitcoin Trading?
To participate in leverage trading, you must open a trading account in a crypto exchange. The size of the collateral required will vary based on the leverage you choose and the value of the position you open, also called a margin. Next, you must fund your account with an initial capital amount, which becomes your collateral. The minimum amount depends on your selected crypto exchange, while the leverage could go up to 100 times your account balance in some cases.
Leverage is expressed as a ratio such as 1:5 (5x), 1:20 (20x), or 1:50 (50x) and refers to the diversity of your trading power. Margin creates leverage so you can trade more significant positions than the amount in your trading account. For example, when you enter a trade with a $1000 margin and use it to trade up to 50x, you receive a $50,000 margin size. When you open a $50,000 position on Bitcoin (BTC), you only need to invest $1,000 worth of BTC initial capital, which carries the same purchasing power as $50,000 with 50 x leverage.
Take note that leverage trading also works on two positions:
- Long (bets on a crypto asset’s price appreciating) or
- Short (bets on a crypto asset’s price depreciating)
You open a long position when you believe an asset’s price will increase and a short position if you feel the opposite. You borrow cryptocurrency instead of cash when you trade short. If the digital asset’s price drops, you’ll buy it at a lower price, returning the borrowed Bitcoin and keeping the profit. However, if your long position succeeds, the lender gives you back the amount you deposited as collateral and the profits.
So what happens if the market swings against your position and you lose the trade? The lender liquidates your position and keeps your initial deposit. The only way to keep your position from being liquidated in such a scenario would be to put more funds into your account to prevent your margin from falling below the maintenance threshold. The secret, therefore, of lowering your risk of losing money through liquidation is choosing lower leverage.
Like all other investment forms, trying to achieve wealth via cryptocurrencies has inherent benefits and dangers. Trading crypto with leverage remains among the easiest ways to multiply your capital if you employ relevant knowledge and a clear strategy. This method’s main advantage is that it enables you to trade cryptocurrencies without paying the total price.
Potential Benefits of Leverage Trading in Crypto
The following are some benefits of using leverage to gain considerably by investing a smaller amount of money to increase your chances of achieving a higher potential return:
Higher Profits
Leverage trading enables you to make a considerably more significant ROI using a far smaller investment than other trading methods. Your capital investment is a tiny fraction of the asking price for your chosen position instead of depositing the entire amount.
Trade More Assets
Trading with leverage can help you grow your cryptocurrency portfolio using less capital if you can master sufficient confidence. Investing in several digital asset types instead of only one enables you to make a greater return and maximizes your potential for earning.
Greater Flexibility
Leverage traders have the flexibility to execute more and faster trades than conventional traders. You want to compare it to momentum trading, where you derive fast profits from quick trades facilitated by short-term price fluctuations.
Potential Downsides of Leverage Trading
There’s no doubt that leverage trading presents more benefits than traditional trading. However, there are also potential disadvantages you need to know about before joining the bandwagon. These include:
Higher Losses
Unless you have a keen eye, there are always high odds that you could make some significant loss at some point in your trades. This is especially true when the money market is volatile, meaning leverage trading is best suited for short-term business.
Difficult for Newcomers
Cryptocurrency volatility makes trading with leverage problematic for new traders who have yet to gain experience. Since practice makes perfect, newbies are better off treading with care as they progress up the knowledge ladder.
Tricky Traps
Many new traders have burned their fingers as they tried to raise losing positions to recover a loss, which becomes a tricky trap when trading with borrowed funds. Most experienced traders learned the hard way the importance of remaining composed, starting small, and taking short positions to avoid potentially expensive errors.
Tips for Managing Risk with Leverage Trading in Crypto
Experienced traders know there’s more to profitable trading than simply learning the best trade practices, especially because trading with leverage is a double-edged sword with potential for profits and losses in equal measure. As a result, you can only become a good trader once you’ve learned proper risk management. The following are suggestions for risk management for crypto leverage traders:
Stop-loss Order
When the market doesn’t behave as expected, as it always does, using a stop-loss-order strategy enables you to automatically cancel a trade position at a predetermined price to save your cryptocurrency. This practical plan limits the amount of money you can lose to avoid damaging losses.
Take-profit Order
Traders use a take-profit order strategy to close positions when they hit a certain set amount. It helps protect your gains so they’re not affected by sudden price shifts in the volatile crypto market that could suddenly eat into your profits.
Position Sizing
Position sizing entails thorough planning that ensures you don’t lose too much money. The strategy requires practicing discipline with your remaining funds after making some losses so you know when to stop and avoid burning a significant percentage of your trading capital.
Only Invest What You can afford to Lose.
With all its potential for significant profits, the fortunes in leverage trading can turn the other way instantly. Regardless of how effectively you’ve prepared, it’s always advisable to risk only as much as you can afford to lose or pay back comfortably in case of a loss. This should usually never exceed 5% of your entire cryptocurrency portfolio.
Conclusion
Leverage trading is a powerful force multiplier that enables you to achieve more with fewer resources besides helping you perform herculean profit feats using your crypto trading account. Unlike other trading methods, you can multiply your ROI by two times, five times, ten times, or even more. However, leverage also intensifies volatility, making it possible to lose your investment faster than traditional trading methods.
It’s, therefore, an excellent idea to take a middle-of-the-road approach to reduce your risk potential while deploying your capital. Since perfect timing can be almost impossible, only invest your money in the best low-risk/high-reward positions. Most importantly, the best strategy is to remember that “No Position” is still perfect when you can’t see a compelling opportunity.
