What is leverage in cryptocurrency trading ?

Did you know that you can multiply your gains in crypto trading with the same amount of capital ?

In the crypto trading world, leverage can be very powerful, meaning that you get to control more significant positions from what you initially invest. The appeal of leveraging is that you can make the most of your potential gains without having to increase your cash much.

On the other hand, leverage also risks heavily because losses in this volatile market of cryptocurrency compound fast. The majority of platforms that deal in Bitcoins provide leverage, a critical aspect of margin trading.

In this article, we define what leverage is, explain how it works, and then go ahead to detail the risks and advantages of trading with leverage.

What is leverage in Cryptocurrency ?

Leverage in cryptocurrency trading allows for just that. For an improvement in buying power, leverage serves the purpose of allowing traders to open larger positions, but it comes with a much more modest up-front commitment.

It is basically the act of borrowing money from a broker or an exchange.

For instance, if you have a leverage of 5x, then you will have 5 dollars in value of cryptocurrencies for every dollar that you actually have in them. This means that even slight changes in the prices can trigger greater profit or loss.

Typically, the most commonly offered leverage ratios in crypto trading platforms sit at between 2x and 100x, depending on the trading platform, and depending on the level of one’s experience.

Leverage and margin trading go hand in hand. The amount that you have committed, or the margin, serves as a pledge for the loaned money.

While using leverage in cryptocurrency trading can increase earnings, it also increases risk. For this reason, effective application of the right cryptocurrency leverage tactics will come in handy in controlling risk and preventing liquidation.

How does leverage work in cryptocurrency ?

With great power comes great responsibility. In Bitcoin trading, leverage can multiply gains and losses many times over. Traders should know this. This is how leverage works:

• Select Leverage

On crypto-exchanges, the trader may choose to apply a specific leverage level, say 5x or 10x.

This determines the amount borrowed compared to the starting capital.

• Collateral

This way, the borrowed money is collateralized.

To secure this amount, therefore, the trader has to deposit what is known as margin—collateral, in other words.

The amount of initial investment goes up directly with declining leverage and vice versa.

• Open a Position

The trader opens a position after employing leverage.

That means with $1,000 you can control $10,000 in terms of the worth of cryptocurrencies.

The ten times leveraged lets you hold a better position in the market; in case the market swings 5% in your favor, you will win $500 instead of $50.

But on the other hand, the same maneuver directed against you may cost you $500.

• Liquidation Price

If the losses cross a set threshold, the exchange will close your position to prevent further losses.

This is called the liquidation price, and it gets riskier as leverage goes up.

The benefits of Leverage

• Higher Profits with Lower Capital

The primary advantage of using leverage for Bitcoin traders is that it brings maximum profits.

This simply implies that with much less initial capital, they can manage much larger positions and afford a handsome profit from even the smallest movements in the market.

• Higher Market Exposure

Leverage is a very good alternative for investors who want to achieve better returns within a comparatively shorter period.

It means the trader can take market exposure without having to commit significant capital.

• Flexibility

Depending on the type of strategy employed and the amount of risk, traders can boast of the flexibility to use different leverage ratios.

For instance, traders who want to maximize their position will find this helpful.

The risks of leverage

• Maxed Losses

Leverage works in the opposite direction. While it magnifies gains, it can also magnify losses.

In other words, when there is slight fluctuation against your trade position, you are likely to lose more than your initial investment.

• Liquidation Risk

The cryptocurrency exchange might automatically liquidate your position if the market swings against your leveraged position and your collateral (margin) drops below a certain level.

This means you have little or no capital left after your trade was forcefully stopped to stop further losses.

• Market Volatility

The Bitcoin market is often known to be very volatile.

Changes in its prices can occur very fast, thereby making leveraged positions very risky to hold

Even the most seasoned traders could run into problems when the market is erratic.

• Increased Trading Cost:

Usually, most of the time you will incur an additional cost when trading with a leveraged position, transaction fees and interest on the borrowed money.

You may end up losing your profits promptly, especially when holding your leveraged positions for longer periods of time.

How to safely use leverage in cryptocurrency ?

• Begin with Minimal Leverage Ratios

To minimize exposure to market volatility, novices should adhere to lower leverage ratios, like 2x or 3x.

• Establish Stop-Losses

Stop-loss orders should always be used to automatically close positions if the market goes against you in order to avoid suffering large losses.

• Utilize risk management

Some cryptocurrency exchange sites offer demo accounts, along with some employing margin monitoring and using risk calculators that allow people to practice with no money at all.

• Increase Portfolio Diversification

Do not put all your eggs in one leveraged position. Diversify it so that any gains or losses will have a possible offsetting effect.

• Leverage only when having a plan

Take the trade only under a good plan, and you should be thoroughly aware of the consequences of that plan.

• Monitor positions

Keep a continued watch on your trades so that you can manage risk and make necessary adjustments, especially when dealing with volatile cryptocurrency markets.

Conclusion

The use of leverage in trading cryptocurrencies offers rather interesting opportunities to increase profits, but great risks are also involved. Trading more safely can be done through instruments such as stop-losses and practice accounts, coupled with an understanding of how leverage works and the importance of risk management. Start small, have a plan in place, and keep following trends in the industry. Go practice first with demos if you’re new to leverage before investing in the cryptocurrency market.