For those interested in trading crypto but do not have a large amount of capital to start with, leverage and margin trading could be the option for you. Leveraged trading lets you borrow money from a broker to increase your buying or selling power, offering the potential for greater profits.
However, leverage trading can be confusing for beginners. Before experimenting with leveraged funds, it’s crucial to understand what it is and how it works. This will focus on leverage trading in crypto markets and its potential upsides and downsides.
How does leveraged trading work?
Crypto leverage uses borrowed crypto funds to increase one’s trading position beyond what would be available from one’s cash balance alone. Such a market position is called a leveraged position.
You put in a fraction of the total order value with a margin trading account. Leveraged funds fill up your order amount. The leveraged/borrowed funds give you increased buying power by allowing you to open more prominent positions than you would ordinarily be able to if you could only use the money in your account.
The number of funds traders can leverage is represented as a fraction or a ratio. For instance, a ratio of 1:10 means that for every unit of crypto, you can get 10 more.
Say you want to invest $1,000 in Dogecoin (Doge) with a 1:10 (10x) leverage. The margin required would be 1/10 of $1,000, meaning you need to have $100 of Doge in your account as collateral for the borrowed capital.
If you use a 1:20 (20x) leverage, your required margin would be even lower: 1/20 of $1,000 = $50. The downside of increased leverage is that it raises the risks of liquidating.
Apart from the initial capital, you will also be required to maintain a margin threshold for your trades. When the market moves against your position and the margin gets lower than the maintenance threshold, you will need to top-up more funds into your account to avoid liquidating. The threshold position is also known as the maintenance margin.
Example of a profitable leverage trade
Leverage can help you to make more profit from a trade, but it can also amplify your losses.
Say your broker offers you 100:1 leverage, meaning you can open positions worth $100,000 with just $1,000 initial capital. You then buy 100,000 DOGE/USDT currency pair units at $0.057 per unit.
With leverage, you only need to put up $57 of your own money (0.057 x 100,000 units / 100x leverage). The rest is borrowed from your broker, making your position worth $5700.
If the market rises by just 5%, your position becomes worth $5,985, giving you 5x profit ($5,985-$5700=$285) on your initial $57 Doge investment.
Example of a loss-making leverage trade
Let’s say you’re using 100:1 leverage, buying 100,000 DOGE/USDT currency pair units at $0.057 per unit. Your leveraged position is worth $5,700 (100,000 x 0.057) using just $57 worth of capital.
Like before, your profits are exponentially higher if the market goes up, but the market would only have to fall by 1% to lose your entire $57 investment.
You can add more funds to your trading account to avoid liquidation to increase your collateral.
In most cases, the exchange will send you a margin call before the liquidation happens – a notification telling you to add more funds to avoid liquidation.
Example of a short leveraged position
Now, imagine that you want to open a $10,000 short position on Doge with 10x leverage. In this case, you will borrow Doge from someone else and sell it at the current market price. Your collateral is $1,000, but since you are trading on 10x leverage, you can sell $10,000 worth of Doge.
Assuming the current Doge price is $0.057, you borrowed 175,438.60 Doge and sold it. If the Doge price drops 20% (down to $0.0456), you can buy back 175,438.60 Doge with just $8000. The trade would give you a net profit of $2,000 without the transaction fees.
However, if Doge rises 20% to $0.0684, you would need an extra $2,000 to buy back the 175,438.60 Doge. Your margin position will be liquidated as your account balance only has $1,000. Again, to avoid being liquidated, you need to add more funds to your wallet to increase your collateral and avoid a margin call or potential liquidation.
Why use leverage to trade crypto?
Because wild market moves allow people to profit from large and fast swings, leverage trading has become a popular trading strategy on cryptocurrency markets such as Binance.
Another reason crypto traders use leverage is to enhance the liquidity of their wallets. For instance, instead of holding a 1:2 leveraged position on a single exchange, they could use 1:4 leverage to maintain the same position size with lower collateral. The extra liquidity would enable them to use the other portion of their money in another place, like trading another asset, staking, liquidity provision to decentralized exchanges, or even investing in Nonfungible tokens.
Disadvantages of leveraged trading include:
- Greater losses
- Capital liquidation risk
- High-risk trading
- Not friendly for beginners
Cryptocurrency Margin Trading Strategies
There are multiple strategies to apply to crypto leverage trading. Here are some to consider for your leveraged trading work.
- Increase your trade sizes gradually, especially for margin trading beginners. Start with Small positions and increase your leverage only as you earn more experience. This is an effective strategy to limit risk.
- Practice leverage trading with a demo account — Using a demo (account funded with test funds) account such as eToro, you can learn the ins and outs of leveraged trading without risking your capital.
- Setting a sensible risk management strategy with clearly defined profit goals can significantly assist you in avoiding emotional decision-making that may result in a loss.
- Divide your positions into separate portions. For example, you could set a series of taking profit orders to capture your profits incrementally rather than all at once when your single take profit is reached.
- Limit the time you hold any position to limit the risk of unforeseen price crashes and long-term market corrections and diversify your portfolio on the crypto exchange.
How to manage risks with leveraged trading
- Stop Loss: A Stop Loss is a risk management strategy designed to close a trade at a specific price if the market moves in an unpredictable direction. It is a constructive way to keep losses in check.
- Only invest funds you can afford to lose, no matter the success rate of your strategy. Margin trading crypto can go against you exceptionally quickly, so you should never invest more than you can afford to lose. As a rule of thumb, risking more than 5% of your account is asking for trouble. You want to invest an amount you could pay off should your account become liquidated.
- Take Profit is the opposite of a Stop Loss. You can set a Take Profit order to close your position when the profits hit a specific price. Because crypto markets are so volatile, getting out before the sentiment turns in another direction can be wise.
Where to Trade Crypto with Leverage?
Not all crypto exchanges support leverage trading, so to begin, you will have to select a crypto exchange first. To ease the process for you, below are the top exchanges where you can trade crypto with leverage:
Bybit:
Bybit is one of the top platforms by active trading volume. The exchange makes it super easy to start crypto trading, and you can buy, sell, or trade popular cryptocurrencies like Bitcoin, Ethereum, Litecoin, Ripple, and more.
The exchange also offers you a wide selection of crypto derivatives, perpetual, and futures contracts.
Bybit offers you up to 100x leverage, one of the highest in the market. Along with that, Bybit charges a low 0.75% taker fee for market orders.
Notably, Bybit charges fees on the whole position and not on your initial margin, meaning you have to pay fees based on your leveraged position.
Binance
Binance is the world’s largest crypto exchange based on trading volume. And for leverage trading, Binance Futures is the best option out there.
With Binance futures, you can trade in 50+ crypto futures with 750+ other crypto and fiat pairs. Some popular cryptos on Binance are BNB, DOGE, ETH, BCH, XRP, BNB, and EOS.
Binance has a diverse portfolio of leveraged products, such as USD-M futures and perpetual margin contracts. Coin-M futures are futures contracts and traditional futures contracts, and Binance leveraged tokens let you trade crypto with leverage and Binance options for options trading.
Binance futures have one of the lowest trading fees in the market. Deposit funds and start trading.
Kraken
Kraken, which was founded in 2011, is one of the industry’s oldest crypto exchanges.
Kraken provides up to 50x leverage on some crypto pairs. Its strong security features, straightforward pricing structure, and consistent dedication to regulatory requirements have reinforced its reputation as a trustworthy option for traders.
Kraken is famous for the large number of cryptocurrencies available for trading. It does not limit traders to well-known coins, but also provides a variety of lesser-known altcoins, encouraging diversification tactics.
Leverage trading on Kraken allows traders to borrow funds to amplify their positions. It provides separate margin and allows traders to choose the level of leverage that best suits their risk tolerance. Isolated margin mode ensures that possible losses are limited to the assigned capital.
Closing thoughts
Leverage is a great trading strategy for seasoned trades; it can be pretty daunting for the uninitiated. Leverage gives users with low initial investment the potential to bring higher profits.
Still, leverage combined with the crypto market volatility could quickly cause liquidations, especially if you prefer higher or lower leverage. Always trade crypto cautiously and evaluate the risks with more capital to avoid margin calls on your account. Keep the leveraged trades and margin threshold in check and take potential profits before the market sentiment changes.
Finally, never trade funds you cannot afford to lose; market volatility can be your foe.