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How to Trade Crypto with Leverage: Pros & Cons
Swen Keller
In the crypto world Swen has consistently found success through his effective communication skills and the unique ability to navigate the details.
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Have you been thinking about starting in crypto trading but don’t have sufficient funds? Or perhaps you are a seasoned trader looking to boost your capital. Leveraged trading just might be what you are looking for. To trade Bitcoin or other cryptocurrencies using leverage, you will have to select the right crypto exchange, arrange the necessary funds, and learn to select the right leverage level.
What Does Trading Crypto With Leverage Means?
Trading cryptocurrency with leverage involves borrowing funds from a platform or exchange to increase the size of your trading position. In traditional trading, you would use your funds to buy or sell an asset. However, with leverage, you can control a larger position than what your initial capital would allow.
Leverage trading can be difficult to figure out for beginners but it essentially allows you to raise your buying power with a small initial investment. While leveraged trading allows you to increase your profits due to the greater trading capital, it also comes with greater risks.
In this article, we will go over what leverage trading is, its relationship to margin trading, and the benefits and challenges that come with this approach. We’ll also talk about sensible trading techniques to help you succeed once you begin trading with leverage.
What is Leverage in Crypto Trading?
Leverage in crypto trading is the amount of borrowed capital that you use for trading cryptocurrencies and other financial assets. It substantially increases your ability to trade with greater capital by borrowing funds than you would have been able to do with the money you have.
The borrowed funds are a form of debt. Even though we hear all the time that we should avoid debt, in real life, traders are constantly looking for strategies to boost their investment returns. Hence, trading cryptocurrencies with leverage can be a high-risk, high-reward strategy. Leverage allows you to borrow funds from a platform or exchange to increase your trading position, amplifying potential profits, but also magnifying losses. It’s essential to approach leveraged trades with caution and proper risk management.
Leverage Ratio
The amount of leverage you have is highly dependent on the leverage ratio. This is a financial measure of how many times your capital is multiplied. You can have a ratio of 1:10 representing 10x leverage or any other ratio such as 1:5 or 1:20.
Let us suppose you have $100 for trading Bitcoin but you want to invest in a position with the market price of $1,000. The 10x leverage ratio raises the value of the $100 to match the $1,000 price tag. This ratio in leverage trading is what allows you to hold more funds with little initial investment.
Types of Leveraged Trading
Leverage trading has recently seen a boost in popularity, especially in the cryptocurrency markets. There are different types you will find, including margin trading and futures trading.
What is Crypto Margin Trading?
Margin or leveraged trading are interconnected in how they work and are often used interchangeably in the cryptocurrency market. Crypto margin trading exchanges are platforms that allow you to create leverage. Margin trading also works on borrowed funds from a broker as an interest-based loan. Margin trading, therefore, lets you enjoy greater profits but also puts you at a greater risk.
With leverage, traders enter a margin position for which they are required to set aside a particular percentage of the entire value of their trade as collateral. This collateral is essentially what the initial or required margin is. Due to the volatility of crypto markets in general, the exchange or broker will set a security measure for themselves. The maintenance margin, thus, becomes the minimum amount of money you have to keep in your account to be able to carry out cryptocurrency margin trading.
Margin Call
If a trader is unable to meet the maintenance margin and the equity drops below this predetermined level, they will receive a margin call. It is a warning to the trader to add more funds to their margin account to meet the predetermined amount.
If the requirements are not met in the time allotted by the exchange, you can face liquidation where the broker holds the right to sell securities and end margin trades early to recover their funds. They can do so without your consent. Some exchanges will go as far as to not allow traders to margin trade crypto on the platform if they fail to comply with the requirements of the warning.
Isolated Margin Trading
Isolated margins are another way of crypto margin trading that allows the trader more protection. Using this technique, you can allocate a certain percentage of your total capital as the collateral for a specific margin trade while keeping the remainder isolated from that trade.
This approach allows an individual to manage risk exposure with crypto margin trading, thus, reducing the chances of facing liquidation because of a single trade going south. It also lets them maintain flexibility while efficiently managing their overall margin trading portfolio.
What is Futures Trading?
Futures trading is also based on the concept of borrowed money. As a type of derivatives trading, these derivatives market contracts act as agreements for the sale or purchase of a particular asset at a predetermined future date and at an already decided price.
Derivatives trading, therefore, allows you to track and speculate the potential price of an asset and create larger profits for yourself, depending on how the market moves without actually being owners of that asset. Futures trading is carried out on popular platforms such as the CME Group or cryptocurrency exchanges such as Binance Futures.
Similar to how margin trading works, futures trading requires you to deposit an exchange-specified initial margin for a position to get opened, along with the maintenance amount to keep that position open. Instead of a margin trading account, you will need a brokerage account that has been authorized for trading futures.
Compared to margin trading where you are needed to pay a higher leverage of at least 50% of the equity value of the margin account as the initial investment, the amount for futures is set at 3% to 10% of the contract value. Taking advantage of this lower cost, you can take on larger positions, thus, boosting your potential for earning greater profits.
Futures Trading Contract
A futures contract is an agreement between a seller and a buyer that binds the buyer to acquire the asset in question at the predicted price on a particular date, and the seller to deliver the asset with the same conditions once the futures contract has expired. The contracts are identified by their expiration dates. The predicted price is not related to the market conditions and may be less or more, depending on how accurate your prediction is. The profits or losses are settled daily with future contracts.
Hedging in Futures
Hedging is another useful risk management strategy employed by traders and investors in futures trading to counteract prospective losses in their current positions. This is done to safeguard against negative price changes in the asset by taking opposing positions in the futures market.
Hedging is primarily used to reduce risk and preserve the value of an existing investment or portfolio, and not necessarily to generate larger profits. Traders can efficiently hedge against potential losses by employing futures contracts to create positions that move in the opposite direction of their initial ones.
How To Carry Out Crypto Trading with Leveraged Positions and How It Works
One of the best ways to create leverage in your investments is by employing margin trading. Now that you have a greater understanding of what margin trading is and its different components, it will be easier for you to follow the crypto leverage trading process. You will first begin by choosing a reliable trading platform that makes it easy for you to start with leverage trading. Some of these trading platforms include Oqtima, Pepperstone, IC Markets, and Exness.
Look for a robust security system, an overall positive user experience, favorable trading strategies, and the availability of leverage on assets you want to invest in. You will also be asked to complete the KYC verification process for the trading platform. This entails the submission of identification documents in line with the latest regulations, and will greatly help in improving the security of your funds.
The first thing you need to do before you jump into crypto leverage trading is to add funds to your account. The capital you add initially acts similarly to the collateral you deposit in margin trading. The amount of collateral, in turn, is based on how much leverage you require for investment purposes and the entire cost of the position you plan to open.
You will also have to decide on the maintenance margin and keep sufficient funds above this threshold to avoid a margin trading call and a possible run-in with liquidity providers. Once you have funded your account, you can move on to selecting the appropriate leverage level based on how much risk you are willing to take on. Higher leverage does bring in more profits, but it also makes you vulnerable to greater loss.
Leverage trading traders should carry out substantial monitoring and technical analysis of the cryptocurrency market, in case the volatile market moves rapidly and you need to exit a position before you sustain any significant losses.
Leverage Trading through Long or Short Positions
Leverage trading can be used for both long and short positions. Opening a long position means that you are predicting that the price of an asset will increase, while a short position indicates that the cost of the commodity is likely to fall. We will go over some examples of how leverage works with these two positions.
Leverage in Long Positions
Let us assume that you are looking to open a Bitcoin long position at a value of $10,000 with 10x leverage. This would make your collateral only $1,000 and even a 20% increase in the price would lead to a $2,000 profit. This is a substantial gain compared to the $200 you would have acquired if you traded without leverage.
On the reverse side, if the value of the Bitcoin suddenly drops by 20%, it will automatically lead to the closure of your position due to the lower amount of collateral, i.e. $1,000. Your entire position would, hence, be liquidated, draining your balance to zero.
Leverage Trading in Short Positions
Building on our long position example, let’s say that you want to open a Bitcoin short position at $10,000 with a leverage level of 10x. You can choose to carry out Bitcoin margin trading and borrow the digital currency to sell at market price. Leverage at 10x allows you to sell $10,000 worth of Bitcoin with a collateral value of $1,000.
Leverage traders are also able to purchase cryptocurrency at a fraction of the total cost. Suppose you have burrowed Bitcoin to sell at $40,000. Once the sale is complete, the currency experiences a 20% drop, allowing you to purchase the Bitcoin back at $32,000, resulting in a $8,000 profit. On the other hand, if the value was to increase by 20%, you would require an additional $8,000 to get that Bitcoin back. With a collateral value of $1,000, this would lead to the liquidation of your position.
Risk Management in Leverage Trading
Leverage trading can be an incredibly lucrative endeavor, especially in the form of margin trading, but this opportunity for raising higher funds to trade with also comes with certain risks and challenges. It is important, therefore, to implement methodical risk management trading strategies to ensure successful trades while giving yourself some protection.
Stop-Loss and Take-Profit Orders
Stop-loss and take-profit orders are advanced tools used in cryptocurrency trading that help protect the trader from major loss of funds. Stop-loss orders can be utilized to close a position automatically as soon as the market price falls below a certain value. You can set this stop order threshold yourself after careful consideration of the market conditions.
Take profit orders work counterclockwise to stop-loss orders and close the position by themselves once the market price rises to a certain value. This allows you to earn the desired profits before there is a detrimental shift in the market and prevents you from staying in positions longer than you need to.
Appropriate Position Sizing
For engaging in a fruitful trading experience, you must select the right size of position depending on the funds at your disposal and the level of risk you are willing to take. Selecting higher leverage may seem like a great idea for quick returns, but the volatility of the digital market can lead to catastrophic losses, therefore, you need to make sure you are tempted to over-leverage.
Determining Risk Per Trade
Before you begin leverage or margin trading, it is important to decide the percentage of the amount of capital you are willing to risk with every trade you make. Most experts will advise you to avoid putting down any amount higher than 3% to 5% of your funds, even if the trade looks very promising. This is because the outcome of a trade can flip at any moment and your gains can be turned into losses. You should also take into consideration the risk-reward ratio for trade and only select trades where the value of the likely gains is considerably higher than the risk of potential losses.
Conclusion
Now that we have discussed leverage trading in depth, you should have a better understanding of how this trading practice works, the benefits it offers, and its impact and relationship with other types of trading tools such as futures and margin trading. Leverage in cryptocurrency trading has the potential to generate substantial gains and may require very little capital to start with.
Conversely, leverage can be risky, and it’s possible to lose more than your initial investment. Using leverage requires proper risk management and an understanding of the potential consequences. It’s crucial to have a solid trading plan, set stop-loss orders to limit potential losses, and avoid over-leveraging.
FAQ
Most frequent questions and answers
Leverage of 20x on $100 will increase your funds to $2,000.
The maximum leverage in crypto margin trading is the largest permitted size of a position that can be opened through a leverage account. The maximum leverage in crypto markets can be very high with some exchanges offering 100x leverage, meaning that you can leverage funds one hundred times your original collateral investment.
100x leverage means that you can borrow funds that are 100 times the initial investment you have made. There are only a handful of exchanges that offer this high level of leverage which include BitMEX, Bybit, and PrimeXBT.
If you are looking for the best cryptocurrency for leverage trading, there are multiple factors that you need to consider such as the available trading pairs, liquidity, and the trading strategies that can be implemented. The leading digital currencies for leverage trading include Bitcoin and Ethereum, the former due to its larger market share and high degree of liquidity, and the latter because of its availability on multiple platforms and better leverage options.
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