Leverage meaning

Leverage is a tool that allows the use of borrowed funds for trading with minimal initial capital.

What is leverage in crypto?

Leverage in crypto trading stands for the usage of borrowed funds to make high-value trades. This tool helps crypto traders get more capital to spend on trades with smaller initial investments.

The initial investment in proportion to the capital that a trader might control is what the leverage ratio shows. The ratio might look like 1:5 (5x), 1:20 (20x), or 1:50 (50x).

Using 50x leverage, a trader can control $50,000 worth of assets with just $1,000. If the price rises by 10%, the trader makes $5,000 in profit. But if the price drops by 2%, the trader loses their initial $1,000.

Being a popular but risky strategy, leverage can significantly increase the profit, but at the same time, it increases the risk of losses during periods of high volatility. In crypto trading, leverage is commonly used in futures and margin trading. Before opting for leverage in crypto trading, it’s essential to have a full understanding of the matter of leverage.

How does leverage in trading work?

To make use of leverage, traders are to first deposit funds into their trading account. Many exchanges facilitate this process through a crypto processing provider. This deposit acts as the initial margin. The amount required depends on the leverage ratio and the size of the trade.

For instance:

• A $1,000 position with 10x leverage requires an initial margin of $100.
• A $1,000 position with 20x leverage reduces the required margin to $50.

Higher leverage reduces the upfront capital requirement, but it increases the risk of liquidation. As a result, traders can lose their entire margin if the market moves unfavorably.

In addition to the initial margin, traders are to maintain a minimum margin level, known as the maintenance margin. If a trade moves against them and the margin balance falls below this threshold, traders must add more funds or risk forced liquidation by the exchange.

For example, if traders open a 10x leveraged position and the market moves significantly against them, they may need to deposit additional funds to maintain their position. Otherwise, the exchange may automatically close the trade to cover potential losses. This is how forced liquidation works.

Pros and cons of leverage trading

When opting for leverage trading you are to be familiar with its strong and weak sides.

Pros of leverage trading:

• Market exposure with a small initial investment.
• Opportunity for large returns even with minor market movements.
• Access to more trading opportunities.
• A flexible investment portfolio that helps traders adapt to changing market conditions.
• Hedging tools to mitigate investment risks.

Cons of leverage trading:

• Even minor price fluctuations can cause substantial losses.
• Forced liquidation if your account balance drops below the required margin.
• Crypto trading platforms charge fees for borrowed funds.

What are common cryptocurrencies for leverage trading?

Any cryptocurrency with high liquidity and market share can be used for leverage trading. However, common cryptocurrencies are:

• Bitcoin (BTC). Since Bitcoin payments are widespread in the crypto market, BTC is often used for leverage trading. Another factor that influences it is BTC’s high market cap and low fluctuation.
• Ethereum (ETH). It’s frequently used in combination with stablecoins by traders who aim to enter DeFi and NFTs.

How to start leverage trading?

Leverage trading begins with selecting a broker that offers access to financial markets. A trading account should be opened and verified through the broker’s Know Your Customer (KYC) process. Upon approval, account details are provided.

A suitable trading platform should be chosen. It’s recommended to use a demo account first to familiarize users with the platform before starting live trading.

Common mistakes to avoid

• Trading without a stop-loss order may result in losing all funds, including the loan and initial margin.
• Opening too many positions simultaneously increases risk, as managing multiple trades requires significant time and attention.
• Overleveraging occurs when a trader takes on more debt than they can afford to lose.