Trading as a concept in cryptocurrency has witnessed evolution over the years through the different ways crypto holders go about it. This development, in turn, increased the adoption of cryptocurrency exchange by enthusiasts. As a result, many are now intrigued by the growth of cryptocurrencies, non-fungible tokens, and decentralized finance (DeFi).
In light of all these occurrences, the cryptocurrency exchange space witnessed a spike in the trading volumes, which imprinted the fear of missing out on prospective significant profits in the minds of several traders. This reality leads these traders to borrow funds or capital from brokers to heighten their purchasing power with high hopes that they'll get massive profits. This concept is what defines leverage in cryptocurrency trading.
Leverage trading can take a complicated turn, especially for users new to the concept. That's why it's equally important to understand its primary idea fully and how it functions. This article will talk about what it means in cryptocurrency markets.
What Is Leverage In Cryptocurrency Trading?
You can define leverage as the use of borrowed capital for trading cryptocurrencies. You can also use it to trade some other financial assets. Leverage heightens the purchasing or selling power of crypto holders so that you can trade with better capital than the one you already have in your wallet.
A ratio is what they call the leverage amount. This measurement expresses the number of times your initial capital gets multiplied, and it comes in different formats - 1:5 means 5x, 1:10 for 10x. So take, for instance, you wish to launch a position valued at $500 with only $50 in your exchange account. It sounds impossible, right? However, with 10x leverage, you can increase the purchasing power of the $50 in your account to have $500 worth.
An example of Leverage in cryptocurrency trading is shown below; using the Remitano Swing feature you can choose to use the Margin 2x and Remitano assumes 50% of the investment for the swing trade.
Leverage also comes in several forms. Some of its common types are leveraged tokens, margin trading, and futures contracts.
Read: A practical guide on how to use Swing in Remitano
How Does Leverage In Cryptocurrency Trading Work?
As you might have hinted above, you need to have a trading account with funds inside before you get the opportunity for leverage and begin trading with it. This first capital required from you is known as the collateral. The complete worth of the position you wish to launch is the margin. This margin calls the shots on the collateral required. The leverage you use is also a determinant.
So take, for example, you wish to invest $2,000 in Bitcoin with a leverage ratio of 1:10, which means 10x. The margin needed would be 1/10 of your investment, which means that all you need to open the position would only be $200. This $200 in your account acts as the collateral for the money borrowed. If you use a 5x leverage, the margin required will take a higher turn (⅕ of $2000). Note that the lower the leverage, the lower the risks of your funds' liquidation.
You would have also noticed positions mentioned in different places above. They come in two forms which are either long or short. You can open a long position if you have faith in the price increase of digital assets. A short position, on the other hand, has the tables turned. Here, you believe that the asset price will take a fall. And as much as these may come across as basic spot trading, leverage here gives you the chance to purchase or sell assets depending on your collateral. Your holdings aren't needed here. This development means that even if you lack an investment, there's a choice to borrow it for selling if you believe that the market will take a lower turn.
Why Should You Use It?
You now know that you can expand the magnitude of your position and increase prospective profits with leverage trading. But apart from these, there are some other reasons you should consider leverage trading as a choice. One is its ability to improve your capital's liquidity.
With leverage, you can use a 4x leverage instead of a 2x one on a single exchange to hold a similar position volume with reduced collateral. This way, you get the opportunity to put the other parts of your funds into use in other places. You can embark on other investments, stake them or even trade another financial asset. Another is the versatile ways you could about leveraging. For example, leveraged tokens are simpler forms with low liquidation risks. Margin trading and futures contracts also work in unique spaces, all from the seeds of leveraging.
Looking to Invest in crypto? Start Here.
Risk Management In Leverage Trading
Like several other cryptocurrency activities, leverage trading also comes with its fair share of risks. Just like how these existing activities have survived through managing their risks, leverage trading has also found a way with them. Here are a few;
To begin with, take good note of trading with high leverage. Though high leverage trading might require lower capital to start with, the chances of liquidation get heightened here. In addition, with high leverages, any slight change in the price movement can make or break your losses.
The lower the leveraged position, the higher your volatility tolerance also gets. Lower leverages also lead to a higher trading margin of error.
- Stop-loss and Take-profit orders.
These risk management methods also assist in reducing losses in leveraged trading. For example, with stop-loss orders, you can choose to automatically put your position to a halt at a particular price. This strategy helps, especially when the market doesn't work in your favour.
In the case of take-profit orders, positions take a halt when your profits attain a particular place. So it's the opposite of stop-loss orders. So you can safeguard your earnings before the market isn't in your favour anymore.
- Negative Balance Security
A couple of trading platforms offer this strategy. This method helps reduce the risk of losing more money than the one in your account. However, these platforms also agree to cover the loss if your account's equity doesn't make a positive turn because of the leverage.
Related: Crypto Lending Explained.
Final Thoughts
Like several innovations in the cryptocurrency space, leverage in trading comes with its rewards and risks. Just buying Bitcoin or Ethereum and selling them carries its share of benefits and shortcomings. Do your due diligence, weigh your choices and do your best to trade with all these in mind. You can still lose a significant amount of money even with leverage, so don't trade those you can't bear losing. So leverage trade with the funds you feel comfortable losing.
