When Leverage Trading Crypto, leverage refers to borrowing capital. Your buying or selling power can be amplified by leverage trading, allowing you to trade larger amounts. Therefore, even if your initial capital is small, it can be used as collateral to make leveraged trades. Leverage trades can multiply your profits, but they are also subject to high risks – particularly in the volatile crypto market. Use leverage carefully when trading crypto. Your position may suffer substantial losses if the market moves against you.
Trading with leverage can be confusing, especially for beginners. But it’s important to know what it is and how it works before you experiment with it. This article focuses on leverage trading in crypto markets, but much of it is also applicable to traditional markets.
What is leverage in crypto trading?
The term leverage refers to borrowing money in order to trade cryptocurrencies or other financial assets. You could borrow up to 100 times your account balance on a crypto exchange if you trade on it, so you are able to trade with more capital than you have in your wallet.
A ratio is used to describe the amount of leverage, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). For example, you have $100 in your exchange account and want to open a position worth $1,000 in bitcoin (BTC). You get the same buying power with $100 if you leverage it 10 times.
Margin trading, leveraged tokens, and futures contracts are common types of leveraged trading in crypto derivatives.
Leveraged trading: how does it work?
You must deposit funds into your trading account before you can borrow funds or trade with leverage. The initial capital you provide is referred to as collateral. The amount of collateral you need depends on the leverage and the total value of the position you wish to open (known as margin).
You have $1,000 to invest in Ethereum (ETH) with a 10x leverage. If you use a 20x leverage, your margin would be even lower (1/20 of $1,000 = $50). If you used a 20x leverage, you would have to have $100 in your account as collateral. In any case, the greater the leverage, the greater the risk of liquidation.
You will also need to maintain a margin threshold for your trades in addition to the initial margin deposit. You will need to put more funds into your account if the market moves against your position, and your margin drops below the maintenance threshold. The maintenance margin is also called the threshold.
In a long position, you expect the price of an asset to rise. In a short position, you believe the asset’s price will fall. Leverage can be applied to both long and short positions. You can buy or sell assets using leverage based only on collateral, not on your holdings, although this may sound like regular spot trading. If you think the market will fall, you can still borrow an asset and sell it (open a short position) if you don’t own it.
Example of a leveraged long position
With a 10x leverage, suppose you want to open a long position of $10,000 worth of Bitcoin. Using $1,000 as collateral, you would make a net profit of $2,000 (minus fees) if the price of Bitcoin increases 20%, which is much higher than $200 you would have made without using leverage.
A 20% drop in the BTC price would cause your position to lose $2,000. As your initial capital (collateral) was only $1,000, a 20% drop would result in a liquidation (your balance would be zero). In fact, even if the market drops only 10%, you will be liquidated. Depending on the Crypto Trading Platform you use, you will have to determine the exact liquidation value.
You need to add more funds to your wallet to avoid liquidation. In most cases, the exchange will send you a margin call before the liquidation takes place.