As cryptocurrency trading continues to grow in popularity, it's not a surprise that a lot of the same market dynamics involved in trading stocks have made their way onto the crypto trading world. One of these common features available on trading platforms is leveraged trading also known as cryptocurrency margin trading. What
Trading cryptos on margin works in a very similar way as trading stocks but instead of borrowing money from your broker, you are borrowing the funds directly from cryptocurrency exchanges. What this means for traders is that they can greatly increase their buying power while only putting up
How Does Leverage Trading Work?
Leveraged trades are essentially borrowing against the value of your holdings. This is one of many trading methods helps traders increase the size of their trades, and by extension, their profits.
Leverage works in terms of multiples. You start with the current value of your existing asset with a broker. The broken can then give you a leverage multiplier which you can then use to buy other assets in the hopes that their price will appreciate
The first step to understanding how leverage trading work with cryptos is to have a clear idea on just how much you can borrow from your broker. In the crypto currency markets, most exchanges don't allow for traders to borrow more than 20:1 which means that if a trader deposits $1000 on an exchange,
Let's run through an example using well-known crypto currency like Bitcoin (BTC)
Let's say that the current price of 1 BTC = $10,000 and you decide to borrow 20 times leverage or 2 BTC. What this means is that you are able to purchase 40 BTC with only 5% margin requirement. If at any point in time, your position starts losing money, there can be a serious risk involved because you are borrowing funds.
Because of the high volatility, many traders and investors see opportunity for more money and larger profits if they trade crypto on margin. What they don't realize is that it's a double edged sword when you borrow money. Potential profits could easily become huge losses.
For another example, if you're with a buyer that has a leverage of 100x or 1:100. This means that your Bitcoin position of $500 will enable you to buy as much as 50,000 USD worth of crypto assets. This is margin trading.
Your initial Bitcoin position of 500 USD is your collateral. The value difference between 50,000 and 500 is your margin. Using this margin is similar to that of a traditional market; the only difference is that you have to consider the uptrends and downtrends.
Advantages and Disadvantages of Leveraged Trading
It’s interesting to note that there is an equivalent downside for every potential upside of leveraged crypto trading.
Take, for instance, the opportunity for greater profits. Just as much as it is a possibility, there’s also that disadvantage of having greater losses.
Let’s say you invest 200 dollars. Using a leverage ratio of 1:10, that will place the total value of your position at 2000 dollars. Luckily your trade goes in your favor such that the price of Bitcoin goes up by 5%. This increase would mean that you are also making 5% of 2000 dollars which is 100 dollars. That amount represents half of your initial investment of 200 dollars; hence that’s an excellent payoff.
On the other hand, if you cashed in the full amount of 2000 dollars instead and the same thing happened. 100 dollars will still equate to 5% compared to your leveraged position where you profited at 50%. However, with your magnified profits, so will be your losses if the value of Bitcoin goes down.
Leveraged crypto trading allows diversification of portfolio, but at the same time, you involve yourself in high-risk trading. It allows you to trade even with limited funds. However, you can easily lose capital under volatile markets. This is why it's important to use a risk management tool and things like negative balance protection so that you are in control of exactly how much money you can potentially lose.
The system itself will help you learn more about risk management and disciple; it can be a challenge for an inexperienced trader to get the hang of. You have to keep in mind that trading cryptocurrencies always will have risks involved, no matter how the market moves.
Use Your Margin Wisely
Just like in stock trading, it's very tempting to look at your margin amount as actual money. It isn't. It's just a loan to you from the trading platform you're using.
If the value of your investments goes down, you will face a margin call. This is the point where the crypto exchange that you're on will start to liquidate your collateral to cover your losses.
How to Make Money on Your Available Margin
Since the broker you're using is extending your credit, use it wisely to buy assets that have a good chance of going up. When they do go up in value, you can choose to liquidate your margin position and what's left is your actual profit.
For example, if you have a Bitcoin position of 500 USD and your position has a margin of 1:100, this means that you can buy 50,000 USD worth of Bitcoin.
Let's say the value of your purchase went up to 60,000 USD. You can choose to pay off the margin and the remaining $10,000 goes to your profit minus fees.
This sounds exciting. The problem is, trades don't always go your way.
What if instead of the value of your position going to $60,000, it went down to $40,000? In that case, you may be facing a margin call, and your collateral might be reduced or liquidated to cover your losses.
You Can Also Use Leverage to Sell Short
It's easy to understand how traders can make money when using leverage to buy long. (This is the idea of expecting the crypto asset to go up in price.)
But leverage trading can also help you make money when the asset price goes down. This is called a short position.
You can use your leverage to borrow the crypto asset at a high price and wait for it to crash and then cover your initial purchase. The difference between the high price that you sold and the low price that you bought is your profit.
Which Crypto Trading Exchanges Offer Leveraged Trading?
There are a variety of cryptocurrency exchanges that offer margin trading, including Poloniex and Bitmex. What they all have in common is the ability to put up collateral to receive a loan from your broker so you can invest more than what you actually have.
Before choosing an exchange that offers this service, it's important know the risks involved. Look for reviews online.
The most prominent crypto exchange that offers leverage trading is Binance. It has the highest liquidity, trading volume, and market players of all other cryptocurrency exchanges. Nobody comes close.
On top of that, Binance also offers a very wide range of crypto offerings you can buy or sell on margin. This platform is also very easy to use.
The downside to Binance is that it is stepping on many regulators' toes and an increasingly lost list of countries have actually prohibited the use of Binance.
Make sure that you look into the local financial regulations of the jurisdiction you live in to see if you can use Binance.
Another exchange that offers leverage is FTX. Established in May 2019, its main claim to fame is the tremendous amount of liquidity this exchange offers.
Finally, you can also try Kraken. It offers margin trading as well as spot derivatives.
On Kraken, the leverage allowed for transactions is five times or 500%. Kraken is also well known for offering a fairly wide variety of different crypto tokens.
The Final Word on Leveraged Trading
Leveraged trading enables traders to maximize the value of their assets. They're able to buy more crypto and lock in on bigger profits by multiplying the total asset value of their initial holdings.
But you have to keep in mind that with great leverage comes great responsibility
Just as margin trading enables you to increase the value of your trades, if you suffer losses, you may end up losing your starting holdings and possibly even owing money.
The bottom line: Use leverage responsibly and have a risk management strategy.