Leverage in digital currencies
Leverage trading can be confusing, especially for beginners. But before trying leverage, it is essential to understand what it is and how it works. This article will focus on leveraged trading in cryptocurrencies, as well as some additional information about its relationship to the traditional markets.
Leverage refers to the use of borrowed capital to trade digital currencies or other financial assets, and it amplifies your buying or selling power so that you can trade with more capital than you currently have in your portfolio. Depending on which cryptocurrency exchange you trade on, you can borrow up to 100 times the balance
The amount of leverage is described as a ratio such as 1:5 (5x) or 1:20 (20x). These ratios show how many times your initial capital is multiplied. Let’s say you have $100 in your exchange account, but you want to open a $1,000 position in Bitcoin (BTC). With 10x leverage, $100 will have the same purchasing power as $1,000.
How is leverage used in digital currencies?
Before you can borrow money and start trading using leverage, you will first need to deposit money into your account which is the initial capital known as margin to cover the leverage you have chosen to open one of your trades, which is used by the broker to cover any losses that may occur to the account while trading. The amount of margin required depends on the leverage you use and the total value of the position you want to open.
Let’s say you want to invest $1,000 in Ethereum (ETH) with 10x leverage. The required margin will be 1/10 of $1,000, which means you need $100 in your account as collateral for the borrowed funds. If you use 20x leverage, the required margin will be even less (1/20th of $1,000 = $50). But keep in mind that the higher the leverage, the higher the risk of liquidation.
Apart from the initial margin deposit, you may also need to add an additional initial margin amount in case of losing trades called the covering margin amount and also called the protective margin. This is to avoid liquidation of your account and to secure the margin that enables you to keep your position open when the market moves against your position.
In other words, the margin of protection is an additional amount required by the broker (margin call) in case the market moves against you. The goal is to ensure that there are enough funds in your account to fund the value of your current position – covering any running losses.
Leverage can be applied to both long and short positions. Opening a long position means that you expect the price of the asset to rise, while opening a short position indicates that you believe the price of the asset will go down. While it may look similar to spot trading, the use of leverage allows you to buy or sell assets based solely on your security and not on your holdings. So even if you don’t have an asset, you can still borrow and sell (open a short position) if you think the market will go down.
An example of a long position with leverage
Let’s say you want to open a long position of $10,000 in Bitcoin with 10x leverage. This means that you will use $1,000 as collateral. If the price of BTC increases by 20%, you will earn a net profit of $2,000, which is much higher than the $200 you would have made if you traded the $1,000 capital without using leverage.
But if the price of BTC drops by 20%, your position will decrease by $2,000. Since your initial capital is only $1,000, a 20% decrease could lead to liquidation. Remember, you can get liquidated even if the market only drops 10%. The exact filter value will depend on the exchange you are using.
To avoid liquidation, you will need to add more funds to your portfolio to increase your collateral. In most cases, the exchange will send you a margin call before liquidation occurs.
An example of a short position with leverage
Now suppose you want to open a short position of $10,000 in BTC with 10x leverage. In this case, you would borrow BTC from someone else and sell it at the current market price. Your collateral is $1,000, but since you are trading with 10x leverage, you can sell $10,000 worth of Bitcoin.
Assuming the current Bitcoin price is $40,000, you borrow 0.25 Bitcoin and sell it. If the price of BTC drops by 20% (to $32,000), you can buy back 0.25 BTC for just $8,000. This will give you a net profit of $2,000.
But if BTC rises 20% to $48,000, you will need an additional $2,000 to buy back 0.25 BTC. Here your position will be liquidated because your account balance does not exceed $1000.
To avoid liquidation again, you will need to add more funds to your portfolio to increase the collateral before the liquidation price is reached.
Why use leverage to trade cryptocurrencies?
As mentioned earlier, traders use leverage to increase their position size and increase potential profits. But as shown in the above examples, leveraged trading can also result in losses that are much higher than expected.
One of the reasons why traders use leverage is to enhance the liquidity of their capital. Instead of holding a 2x leveraged position on one exchange for example, they can use 4x leverage to maintain the same position size with less security. This will allow them to use the other part of their money elsewhere.
How do you manage the risks of leveraged trading?
Trading with high leverage may require less capital to get started, but it increases the chances of liquidation. If your leverage is too high, it can lead to huge losses even if the price movement is only 1%. The higher the leverage, the less risk you can take. Using lower leverage gives you a greater margin of error, which is why Binance and other cryptocurrency exchanges are limiting the maximum leverage available to new users.
Risk management strategies such as stop-loss orders help reduce losses in leveraged trading. You can use stop-loss orders to automatically close your position at a specified price, which is very useful when the market is moving against you. Take Profit orders do the opposite, as they are automatically closed when your profits reach a certain value, allowing you to lock in your profits before the market situation changes.
Obviously, leverage is a double-edged sword, as it can greatly multiply your gains and losses simultaneously.
How to trade margin on Binance?
You can use leverage to trade cryptocurrencies like Binance. Below you how to trade on margin
Follow Step on Open this Binance
1- Go to [Spot] -[Margin] to access the margin trading interface
2- Click on [BTC / USDT] to search for what you want to trade. We will use BNB/USDT in this example
3- Transfer funds to your margin portfolio by clicking on [Transfer Collaterals] below the candlestick chart
4- Select the wallet through which the funds will be transferred, the margin account and the currency to be transferred. Enter the amount and click [Confirm]. In this example, we are transferring 100 USDT to a Cross Margin account.
5- Now go to the box on the right, then choose either [Cross 3x] or [Isolated 10x]. The margin you put in Cross Margin mode is shared between your margin accounts.
6- Select [Buy] or [Sell] and the order type. Click on [Borrow] and you will see that the 100 USDT we transferred to the Cross Margin account has now tripled to 300 USDT.
7- You can buy BNB with leverage by entering the amount of USDT with [Total]. You can also drag the bar below to select the percentage of credit available to use. You will then see how much you are borrowing for this transaction. Click on [Margin Buy BNB] to open the position.
Leverage allows you to achieve higher profits with a small initial investment, but at the same time it may cause huge losses, especially if you use high leverage. Remember to always trade with caution, and to assess the risks before deciding to trade with leverage. You should never trade with money that you cannot afford to lose, especially when using leverage.
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