In crypto trading, leverage refers to using borrowed capital to make trades. Leverage trading can amplify your buying or selling power, allowing you to trade larger amounts. So even if your initial capital is small, you can use it as collateral to make leveraged trades. While leveraged trading can multiply your potential profits, it is also subject to high risk - especially in the volatile crypto market. Be careful when using leverage to trade crypto. It may lead to substantial losses if the market moves against your position.
Leverage trading can be confusing, especially for beginners. But before experimenting with leverage, it’s crucial to understand what it is and how it works. This article will focus on leverage trading in crypto markets, but a great portion of the information is also valid for traditional markets.
What is leverage in crypto trading?
Leverage refers to using borrowed capital to trade cryptocurrencies or other financial assets. It amplifies your buying or selling power so you can trade with more capital than what you currently have in your wallet. Depending on the crypto exchange you trade on, you could borrow up to 100 times your account balance.
The amount of leverage is described as a ratio, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). It shows how many times your initial capital is multiplied. For example, imagine that you have $100 in your exchange account but want to open a position worth $1,000 in bitcoin (BTC). With a 10x leverage, your $100 will have the same buying power as $1,000.
How does leveraged trading work?
Before you can borrow funds and start trading with leverage, you need to deposit funds into your trading account. The initial capital you provide is what we call the collateral. The collateral required depends on the leverage you use and the total value of the position you want to open (known as margin).
Say you want to invest $1,000 in Ethereum (ETH) with a 10x leverage. The margin required would be 1/10 of $1,000, meaning that you need to have $100 in your account as collateral for the borrowed funds. If you use a 20x leverage, your required margin would be even lower (1/20 of $1,000 = $50). But keep in mind that the higher the leverage, the higher the risks of getting liquidated.
Apart from the initial margin deposit, you’ll also need 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 put more funds into your account to avoid being liquidated. The threshold is also known as the maintenance margin.
Example of a leveraged long position
Imagine you want to open a long position of $10,000 worth of BTC with 10x leverage. This means that you will use $1,000 as collateral. If the price of BTC goes up 20%, you will earn a net profit of $2,000 (minus fees), which is much higher than the $200 you would have made if you traded your $1,000 capital without using leverage.
However, if the BTC price drops 20%, your position would be down $2,000. Since your initial capital (collateral) is only $1,000, a 20% drop would cause a liquidation (your balance goes to zero). In fact, you could get liquidated even if the market only drops 10%. The exact liquidation value will depend on the exchange you are using.
To avoid being liquidated, you need to add more funds to your wallet to increase your collateral. In most cases, the exchange will send you a margin call before the liquidation happens (e.g., an email telling you to add more funds).
Example of a leveraged short position
Now, imagine that you want to open a $10,000 short position on BTC with 10x leverage. In this case, you will borrow BTC 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 are able to sell $10,000 worth of BTC.
However, if BTC rises 20% to $48,000, you would need an extra $2,000 to buy back the 0.25 BTC. Your 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 before the liquidation price is reached.
Why use leverage to trade crypto?
As mentioned, traders use leverage to increase their position size and potential profits. But as illustrated by the examples above, leveraged trading could also lead to much higher losses.
How to manage risks with leveraged trading?
How to use Margin Trading on Binance?
3. You’ll also need to transfer funds to your Margin Wallet. Click [Transfer Collaterals] below the candlestick chart.
4. Select the wallet to transfer funds, the destination margin account, and the coin to transfer. Enter the amount and click [Confirm]. In this example, we’re transferring 100 USDT to the Cross Margin account.
7. You can buy BNB with leverage by entering the amount of USDT by [Total], or the amount of BNB to buy by [Amount]. You may also drag the bar below to select the percentage of available balance to use. You’ll then see the amount you’re borrowing for this trade. Click [Margin Buy BNB] to open the position.
Leverage allows you to get started easily with a lower initial investment and the potential to bring higher profits. Still, leverage combined with market volatility could cause liquidations to happen quickly, especially if you’re taking 100x leverage to trade. Always trade with caution and evaluate the risks before taking on leveraged trading. You should never trade funds you cannot afford to lose, especially when using leverage.