We have compiled some common questions and provided an overall summary of what you need to know to begin leverage trading in crypto markets. With this guide from Pluto, beginners can get in on the pie as well!
What Is Leveraged Trading?
Leverage trading is an investing strategy that involves borrowing money to advance your investment position to multiply your gains.
You can think of leverage as a loan issued by a cryptocurrency exchange, such as Binance, where the funds instantly hit your account for trading purposes.
Depending on the crypto exchange platform you are working with, you can grow your investment up to 125 times against your collateral. The collateral you provide is called a “margin,” which we’ll explain in more detail later.
Let’s just say that is a whole lot of money to play with and ultimately allows you to maximize your potential profits.
While this may sound all fun and dandy, it is vital to remember that significant risks come with these great rewards. Trading with leverage means that you can also see incredible losses.
Margin trading is another term for crypto leverage trading, where you use borrowed funds to make bets on crypto assets to magnify your profits.
Margin is the designated amount of money you are willing to invest in a trade, also known as collateral.
The amount of leverage you can take out is often expressed in ratios. For example, if you want to add 10:1 leverage to your crypto trade, you will multiply your initial capital or margin by 10x.
To gain this leveraged position, you will need to make the initial deposit, your collateral, to determine how much leverage you will receive.
So, let's say your trading account has $1,000 of your funds, and you want to 10x your leverage. Your $1,000 will then be multiplied by 10 to make $10,000 your new position. Your new position is 10 times larger than the margin.
An “option” can be considered a relatively low-risk and low-cost digital asset for investors rather than trading crypto futures or other swaps.
As a type of derivative contract, options allow a purchaser to buy or sell underlying assets at a set price for a specific period with an expiration date without any obligation to buy or sell.
Options trading involves betting on future prices of designated underlying assets and then settling in cash or cryptocurrencies such as Bitcoin (BTC), Ethereum (ETH), Tether (USDT), or even some altcoin. Trading options also incur upfront fees, known as premiums, before you take profits from the trade.
As mentioned numerous times, you can use leverage to make more considerable gains on bets.
Similarly to options, futures are derivative contracts in which two investors are betting on a cryptocurrency's future price. These future contracts can be considered commodities or stocks because you are betting on the trajectory price of an underlying asset.
The way leverage works for futures trading is a buyer and seller agree on an underlying commodity at a specific price and on a certain date, called a contract. For example, for a Bitcoin future, the underlying asset is Bitcoin.
You can use leverage to increase your potential gains and trading size on future bets.
Futures enable investors to hedge, a form of risk management when trading against volatile markets. If the price moves in the opposite direction of your betted contract, you can end up paying more than the market price or selling at a loss. But if it moves in the direction that your bet lies, you can see significant profits.
A leveraged ETF, also known as leveraged exchange-traded funds, is a security that uses financial derivatives and debt to amplify returns on an underlying index.
In other words, traditional ETFs track securities in their underlying index one-to-one, while leveraged ETFs may go for a 2:1 or 3:1 leverage ratio.
To magnify the exposure to a particular index, a leveraged ETF may use derivatives such as options contracts to track an index.
Due to the high-risk and high-cost structure of leveraged ETFs, they are rarely used as long-term investments. Traders usually hold positions for a few days or less, which can lead to potentially significant gains.
Leveraged Trading in Foreign Exchange
In the Forex market, also known as the foreign exchange market, you can achieve leverage as high as 100:1. This could be because the ability to enter and exit a trade within this forex market at an ideal level is much easier than in other markets.
Trading in the forex market can be tracked by monitoring the currency movements in “pips,” defined as a minor change in currency price and pair. These movements are usually as small as fractions of a cent.
This is why leveraged trading is ideal in the forex market because it can magnify these minute price movements into more significant profits. When leveraging as much as $100,000, these minor changes can result in sizable profits or sometimes even losses.
How Can You Minimize the Risks of Leveraged Trading?
Leveraged trading is indeed a double-edged sword. By using leverage, you have the potential to gain massive profits, but you also risk the possibility of crippling losses.
Therefore, it is crucial to be aware of the downsides of leverage trading and understand the significant risks it carries.
Leverage trading calls for ultimate risk management strategies to curb any losses at a higher risk, with more money being borrowed and entered into a position.
Understanding terms like liquidation is critical. Liquidation in leverage trading is a loss of your entire trading capital due to losses your margin balance could not support.
Some risk management strategies you should exercise while leverage trading would be:
- Thoroughly plan out your trade. You must plan your entry and exit strategy and know your risk and reward. This will mitigate your losses and not leave room for chance. Know what to expect and see the amount you are willing to lose.
- Use a stop-loss order. This type of order limits your loss and will lock in your profit and close out a position. This allows you to control your risk exposure.
- Cap your margin. Monitor how much margin you use per trade and be strict about staying within your designated position.
- Limit your position size. Your position size will directly affect your total gains and losses. If you bet everything, you can quickly lose everything. Just because leverage allows you to trade bigger doesn’t mean you should get ahead of yourself. It is important not to trade too large.
These are just a few risk management strategies you should practice while leveraging trading. As you become a more seasoned leverage trader, you should learn and implement as many risk management strategies as possible to keep risks at bay.
What Should I Know About Leveraged Trading in Crypto, in a Nutshell?
Crypto Margin Trading
- You are making bets on crypto markets using borrowed funds and only using a small amount of your capital.
- Margin trading positions can be opened as either short, where you bet on the price going down, or long positions, where you bet on the price going up.
- Leverage is expressed in rations. For example, 10:1 means you are 10x your collateral position.
Crypto Options and Futures
- Options are a type of derivative contract which give the purchaser the right, not the obligation, to buy and sell an underlying asset at a set price by an expiration date.
- The right to buy the underlying asset is also known as a “call” option. The right to sell is known as a “put” option.
- These options contracts allow traders to bet on the future prices of an underlying asset and can be settled in cash or crypto.
- The three main components in futures trading are the expiration date, which refers to the date on which the futures contract must be settled; units per contract, which defines how much each contract is worth; leverage, which you can access to increase your position.
What Are the Pros of Leverage Trading?
1. Better Profits
With leverage trading, you have the ability to see multiplied profits that you may never have been able to see with your initial investments.
2. Enhanced Flexibility
With more money comes more opportunities and more options. That is the same for leveraged trading. Enrolling your investment position with more significant funds gives you more flexibility to enter long and short positions.
What Are the Cons of Leverage Trading?
1. Mental Stress
Just as leverage trading can be fun, it can also be highly stressful and anxiety-inducing. Imagine betting on futures only to discover that your desired position is trending in the opposite direction. You incur high risks of significant losses, margin calls, or even liquidation. That alone can cause considerable mental strain.
2. Higher Volatility and Risk
Due to the high volatility and risk of the cryptocurrency market at all times, leverage trading adds another layer of enhanced risk. Just as you can make huge profits, you have the same chances of inheriting massive losses.
Take the recent FTX plunge, for example, where the failure of the fourth-largest crypto trading platform (as of November 9, 2022) had ripple effects across blockchain platforms, leading to a further contraction of markets.
3. Can Be Challenging for Beginners
Leverage trading is no easy feat. It can be confusing at first and hard to grasp, especially for beginners. There is a lot to digest.
Leverage trading has been around for some time, and many traders have seen massive profits while practicing this strategy. Inevitably, you do not need to be an expert to start leverage trading, but you need to understand the fundamentals and risks that come with it.