Leverage trading: What? Why and how?
“With leverage or without?” In a world of cryptocurrencies where volatility is always present, risk-taking can yield rewards, but it can also prove to be a fatal choice. One of the biggest risks in cryptocurrency trading (so-called trading) is the use of leverage, especially when you are not good knowledgeable on the subject.
What exactly is leverage? Why is leverage dangerous? These are some of the great questions we’ll cover below so you don’t take unnecessary risks.
What do we mean by leverage?
With leverage, you basically borrow money from the broker to make a better investment with your money. Let’s say you want to buy $1000 worth of Bitcoin, but you don’t have the money. You can use a leverage rate of “10 to 1” and get $1000 worth of BTC for as little as $100, which is that 1st party to the deal or, the so-called “margin” in trading.
What do we do now?
You now have $1000 worth of BTC in your exchange account. The purpose of leverage is not to maintain your position, but to take advantage of the upward changes that the market has.
Let’s say you bet your newly borrowed $1000 on the BTC going up, otherwise known as “Long” (the position we open in favor of the market) and Bitcoin increases by 20%. Now you have earned $200.
But what happens if the price of BTC falls by 20%? You may have guessed it right away, you’ll stay under $200 (remember you only had $100 to start with). This means that any credit you have in your account will be used to cover this loss! In other words, the position will become liquidated, i.e., the money will be liquidated and you will lose it.
For or against the purchase
We mentioned ‘long’ and ‘short’ earlier. What exactly is it and how do they relate to leverage?
Long is basically a bet on the fact that an asset goes up, while short is the complete opposite, you bet the asset will go down. So long means buying an asset and waiting for its price to rise to make the profits. Short, on the other hand, means selling an asset, waiting for the price to fall, and then buying that asset again at a lower cost.
Trading with leverage means using these options to navigate the market with borrowed funds. Although the allure of a great reward is high in a leveraged trade, you run a high risk of liquidation if the market moves abruptly or contrary to your options.
Why is leverage dangerous?
- Liquidation of the position
What does it mean when our position is liquidated?
Well, liquidation happens when the exchange forcibly closes your trading position because the leveraged trade failed due to the deviation.
Given the large gaps between market fluctuations, high-margin leverage in cryptos is borderline suicidal. For example, a leverage of 100:1 would only require a 1% deviation to liquidate your trade.
This deviation occurs when the price of a crypto asset moves away from your intended trading objective. With our example of a 100:1 leverage, you risk losing everything you have if the price goes just 1% in the opposite direction from your bet.
- Getting rekt due to high volatility
The first thing you may have noticed is that using leverage in a volatile market will potentially lead to unpleasant results if one does not have enough experience. The biggest risk you run when playing with leveraged trading is losing your money abruptly.
Depending on the exchange, each broker will impose a certain “security deposit”, based on the amount you invest and want to borrow from the broker. For example, Binance will allow its users to use their crypto assets as collateral when working with leverage/margin trading.
If your transaction goes bad, Binance will use the security in your account to cover your losses. The main point of the course is that using leverage requires a lot of experience. It becomes even riskier when you play with the fire of high margins, such as 50:1 or 100:1.
- Those who don’t know are most at risk
If we look at the stats, we can see a clear trend. Most of the failed leverage trades happen with inexperienced traders. If you are new to cryptocurrency and trading DO NOT attempt to use leverage. You run the greatest risk of becoming a rekt (an expression for when something is compressed-dissolved).
To work properly with a risky tool such as leverage, one needs a deep understanding of mechanics and market dynamics.
If you want to start trading leverage, we recommend that you start with a healthy dose in trading training. Only after reading some serious training materials and having worked with some demo accounts should you consider leverage trading.
How to use leverage trading?
- Never stop learning
Leverage is an extremely risky feature of trading. Regardless of whether you are trading cryptocurrencies, stocks, commodities, gold, forex, and everything else, you should be well informed before you start using it.
Taking a few courses from experienced traders, actively watching several video series on YouTube and absorbing as much information as possible will form the basis of your training for trading with leverage.
- Try before you trade
Some exchanges offer the possibility of working with “paper money”. What it is?
“Paper money ” is basically fake and enables you to trade with virtual money that you do not have. You will have a separate account where you can use your gaming money and start experimenting with 0 risk. You will have access to the same features as in live trading, but you will not risk your money.
Practice until you feel confident enough before you start betting live with your own money.
- Don’t go in with all your money
When you start betting your own money, NEVER ask for more than you can afford to lose. Since the crypto market fluctuates greatly, it is advisable to never work with high margins.
Only after you manage to work with banknotes and small margins, you should commit to using real funds with larger margins.
Inference
Losing only what you don’t need immediately may well be the watchword for leverage trading. Even if this type of trading looks appealing to beginners and can mean big wins, it’s also a trap that can pose a big risk to those who haven’t done their research on the subject.