Leverage is a position size amplifier. Trading with leverage can both supercharge profits and bring disproportionate losses on a position.
What is Leverage Trading?
Leverage trading (also known as margin trading) is the practice of using borrowed capital in financial investments. When trading with leverage an investor increases their exposure to a financial asset through debt in an effort to multiply returns.
The amount of credit a trader borrows from an exchange to purchase a larger position than what their capital allows is called leverage. To receive leverage a trader needs to deposit margin — collateral that serves to cover both the trader’s and lender’s credit risks.
How does Leveraged Crypto Trading Work?
In leverage trading investors purchase financial instruments with funds that may exceed the balance of their account.
To open a leveraged position a trader is required to deposit margin. The amount of leverage is usually described as the ratio between margin and borrowed capital. For example, with 1:10 (10x) leverage the margin is one tenth of the total order value.
Maintenance margin is the minimum capital an investor has to hold in their account after the trade is completed. If an investor’s balance falls below the margin threshold in an adverse market movement, they will be issued a margin call — a request to transfer more funds into the account. Liquidation of a position occurs when a trader is unable to satisfy a margin call and margin becomes insufficient to cover the lender’s losses on a position.
Leverage amplifies both gains and losses from market swings. In an adverse market movement leveraged trades can bring much higher losses than a trade without leverage.
Leverage trading can be used for both long and short positions. When entering a long trade an investor is betting on an asset’s price going up, while short traders usually profit from asset depreciation.
Example of a Leveraged Long Position
Without leverage 18 USDC initial capital will buy a trader 0.01 ETH, assuming ETH/USDC is currently trading at 1,800 USDC. With 10x leverage they will be able to open a position worth 180 USDC (and buy 0.1 ETH).
If ETH/USDC rises to 2,000 USDC the leveraged trade will bring a profit of 20 USDC on an 18 USDC investment, while a trade without leverage will only bring 2 USDC profit.
Example of a Leveraged Short Position
Now let's say a trader decides to go short on ETH with 18 USDC margin and 10x leverage (ETH/USDC is still trading at 1,800 USDC). They will be borrowing 180 USDC worth of ETH (0.1 ETH) and selling it at the current market price.
If ETH/USDC drops down to 1,600 USDC the trader will be able to buy ETH back for 160 USDC and make a profit of 20 USDC.
How to Manage Risk When Leverage and Margin Trading
Trading with leverage amplifies a trader’s potential profits and losses by the same magnitude. The greater the leverage applied to a trade, the higher the risk of an investor losing a significant amount of capital.
Here are some ways to manage risk when trading with leverage:
- Use stop-loss orders. Stop-loss orders close trades automatically once an asset reaches a specific valuation. With stop-loss orders a trader always knows the exact amount of money they potentially risk losing.
- Consider leaving a cash cushion in your margin account to reduce the probability of a margin call.
- Do not risk more than you can afford to lose.
Leverage in Crypto vs. Leverage in Traditional Finance
Cryptocurrency leverage trading and traditional finance leverage trading are inherently similar. As with traditional finance leverage trading, cryptocurrency leverage trading allows traders to achieve higher potential profits on an investment through use of borrowed capital.
Both cryptocurrency exchanges and Forex platforms offer leverage ratios up to 1:100. The maximum size leverage for stocks allowed in the US is 1:4 or 1:2 in the case that the position is held overnight.
Unlike traditional exchanges, crypto exchange platforms currently have no regulatory framework in place to ensure protection of assets for traders. In leverage crypto trading it is not uncommon to incur significant losses on trades that get canceled due to an exchange error.
In this article you can see some examples of the use of leverage in traditional finance.
Where to Trade Cryptocurrency With Leverage
The TabTrader app aggregates multiple exchanges that offer leverage trading. Find the trading pair you are interested in using the search bar at the top of the screen and choose from a variety of leading cryptocurrency exchanges. You can specify the amount of leverage you wish to apply on the order form.
Leveraged Trading in Crypto Pros and Cons
- Greater profits. Leverage trading increases a trader's buying power and can bring large profits on a relatively small investment.
- Increased investment opportunities. When trading with leverage, an investor gains access to trading instruments that would otherwise be outside of their budget.
- Greater losses. Leverage trading amplifies an investor’s potential losses as well as profits.
- High risk. When trading with leverage, it is highly recommended to use a risk management strategy.
- Not suitable for inexperienced investors.
Leverage in Crypto Trading FAQ
How does leverage trading in crypto work?
In leverage trading investors use borrowed capital to increase their exposure to financial assets. By augmenting their buying or selling power traders hope to amplify returns on investment (ROI).
Can you use leverage with crypto?
Leverage trading is common in stocks, Forex and cryptocurrencies.
What does 100x leverage mean in сrypto?
The amount of leverage is commonly described as the ratio between the initial capital and borrowed funds. With 100x leverage the margin is one hundredth of the total order value.
Is leverage trading crypto worth it?
Leverage multiplies both profits and losses on an investment. When trading with leverage it is important to determine the potential loss of capital in advance and establish risk controls.