What Is Leverage in Crypto Trading?
Introduction
Leverage is the process by which one makes investments using borrowed funds. A leveraged trade may allow you to increase the amount of money you can invest or trade. Therefore, you can leverage your small starting capital to make leveraged trades regardless of its size. Despite the potential for increased profits, leveraged trading involves significant risk, especially in volatile markets such as cryptocurrency. Use caution when trading cryptocurrency with leverage. In the event that the market moves in the opposite direction, substantial losses can occur.
Trading leverage can be a complex process, particularly for beginners. However, it is important to take the time to learn what leverage is, how it works and how to use it before you give it a try. It is our goal in this article to discuss how leverage trading is carried out in crypto markets, but the information available in this article can be applied in traditional markets as well.
What is leverage in crypto trading?
A leveraged transaction involves borrowing capital for the purpose of trading cryptocurrencies. You can trade with a greater amount of capital if you have more in your wallet than what you currently have. You may be able to borrow up to 100 times the size of your account balance, depending on the cryptocurrency exchange you use.
There are different ratios in which leverage might be expressed, such as 1:5 (5x), or 1:25 (25x). Leverage is the amount multiplied by your initial capital. For example, suppose that there is $200 in your account but you want to open a position worth $2,000 in Ethereum (ETH). The leverage of 10x will allow your $200 to purchase the same amount as $2,000.
Leveraged trading - how does it work?
Your trading account must be funded before you can borrow funds and use leverage. We refer to this capital as collateral. You have to pay margin on your position depending on the leverage you use and the total value of the position you wish to open (also referred to as a margin deposit).
suppose that there is $200 in your account but you want to open a position worth $2,000 in Ethereum (ETH). The leverage of 10x will allow your $200 to purchase the same amount as $2,000. However, you should remain aware that the higher the leverage, the greater the risk of losing your investment.
A margin threshold must also be maintained for each trade in addition to the margin deposit. To avoid being liquidated, you must place more funds into your account when the market moves against you and your margin falls below the maintenance threshold. Maintenance threshold are also known as maintenance margins.
It is possible to apply leverage to both long and short positions. In taking a long position, you are expecting that an asset's price will rise in the future. A short position, on the other hand, means that you think that the asset's price will fall during the period. You might think that using leverage is just like trading assets on the open market, but it really allows you to buy or sell assets based only on your collateral, not on what you own. In order to be able to use an asset when you do not own one, you can still borrow an asset (open a short position) and sell it, when you believe the market will decline.
How to manage risks with leveraged trading?
It may be cheaper to trade with a large leverage ratio to begin with, but it increases the risk of liquidation. Even a 1% move in a particular market could result in great losses if your leverage is too high. If your leverage is higher, the lower your tolerance of volatility will be.
Risk management techniques, such as stop-loss orders and take-profit orders, reduce losses when trading leveraged securities. In order to close a position automatically, a stop-loss order can be used. This is very useful when the market does not go in the direction you expect. The Stop-Loss Orders are very useful to guard you against significant losses in the market. An opposite of a take-profit order is one which automatically closes when your profits have reached a certain amount. In this manner, you have the opportunity to lock in profits before the market conditions drastically change.
As you can now see, using leverage in trading is a double-edged sword that can increase both your profits and losses exponentially, making it a dangerous proposition. It is indeed a risky process, especially if one deals with the volatile market for cryptocurrencies.