Understanding basic trading concepts is the very first step to becoming a successful crypto trader. Leverage in crypto trading is one of those concepts that beginners need to learn along with other crypto trading strategies and top 5 forex trading strategies in 2023 to make a profit. Leverage borrows extra funds, effectively increasing portion size which allows traders to earn far more than they would use their funds alone. However, it is overall, riskier.
Many, especially beginner crypto traders, still need to clarify the concept of leverage in crypto trading. We put together this article to help you understand leverage trading and make an informed decision on when to and when not to give it a try.
Understanding leverage in crypto trading?
Leverage in crypto and spot trading refers to borrowing funds to trade cryptocurrencies. However, its scope may extend beyond this to borrowing funds to trade other financial instruments like stocks and other assets. Essentially, it is a system where you use borrowed money to make more money. Your leverage extent is also mostly expressed in form of the leverage ratio. This ratio differs from one exchange to another and could also vary from pair to pair.
The leverage ratio indicates the number of times your original funds are increased, from which you can calculate the new total sum. For example, 1:5 refers to x5 and 1:10 refers to x10. Essentially x5 ratio multiplies your original fund by 5 times while x10 multiplies it by 10.
However, note that an exchange can have different leverage ratios for various token pairs. This means that the available leverage on BTC/BUSD might not be the same for SOL/ETH. Additionally, the leverage sum also varies depending on margin, futures, crypto derivatives and leveraged tokens.
Leverage and margin concept are inversely related although they appear similar. Essentially, the higher your margin, the lower your leverage ratio. You can learn more from this beginner’s guide on how to start crypto trading.
How to trade crypto with leverage
Now, onto the steps on how to perform crypto trading with leverage:
Step 1: Firstly, you have to deposit funds to your crypto exchange account which you can use as collateral.
Step 2: Perform a simple calculation of leverage to margin with the specific number you have in mind. For example, to obtain $9,000 worth of ETH with x3 leverage, you need to deposit $3,000 in BTC in your account.
Step 3: Avoid liquidation when a market moves against you by having a maintenance margin or margin threshold by depositing more funds.
Step 4: Trade. Leverage works with both long and short positions. Long refers to anticipating that the asset price will go up, while down anticipates the asset prices will fall.
Something to catch your fancy – Spot trading in crypto – How does it work?
What are the benefits of leverage trading in crypto?
Some of the benefits of crypto trading include:
- The more money you trade with, the higher the profit you’ll make if the market favours you.
- Leverage helps with increasing the liquidity of your funds
- With leverage, you can work with lower collateral when using x4 leverage than betting your whole coin on x2 in a single crypto exchange.
- Leverage funds can be used elsewhere for staking, trading or investing in other cryptos.
What are the disadvantages of leverage trading in crypto?
The major disadvantage of leverage trading in crypto is the fact that if the market moves in a different direction than your prediction, the potential loss can be catastrophic.
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Handling the risks associated with leverage trading in crypto
The potential profits in leverage trading look enticing, however, the risks are just as appalling. Therefore, you always need to consider the possibility of liquidation. Essentially, the higher the leverage, the higher the risk and the smallest market fluctuation may be costly. Leverage trading leaves you with no room for mistakes.
Profession traders apply strategies like take-profit or stop-loss to curb leverage trading losses. Basically, stop-loss automatically closes orders after specific price conditions are met, while take profit, on the other hand, closes as soon as your profit hit your target value.
Leverage in crypto trading gives you the advantage to earn significantly more, however, may also cause heavy losses. Losses from leverage mostly come from your inability to properly manage risks.
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