One of the fundamental notions in the trading world is leverage. Leverage is the term used to describe trading using borrowed money. Leveraging can raise the trade size by providing additional resources enabling traders to earn substantially more than they otherwise can.
However, it can be highly risky, especially in the erratic cryptocurrency market. Therefore everyone must learn about the potential it provides. In the following lines, we will dive deeper into the topic of leveraging cryptocurrency to help you decide whether to give it a try or not.
What is Leverage in Cryptocurrency?
As stated above, leveraging means borrowing funds to amplify potential returns, giving traders an edge to have a larger position in the market. When leveraging cryptocurrencies, traders borrow funds in the form of stablecoins or other digital assets and then use them to generate additional profit.
In crypto trading, you can lend up to 100 times your actual balance, which also depends on the cryptocurrency exchange you are using.
Leveraging can be expressed in ratios like 1:5 or 1:20, where the ratio indicates the number of times the original investment has increased. For instance, leverage of x5 will increase your purchasing power by five times.
How does Leverage in Crypto Trading Work?
Before starting trading using leverage, you must provide collateral, usually in the form of crypto assets. This is also called margin trading. Collateral is the initial sum of money in the trading account and must be deposited before taking leverage.
The amount of collateral that needs to be deposited depends on factors like leverage ratio and type of cryptocurrency. The next step is to decide the required leverage ratio. Suppose your leverage ratio is 5:1, and you deposit $1,000 as collateral; you can trade with $5,000 worth of cryptocurrencies.
These funds are then added to your trading account, and you can now proceed with your investment plan.
Remember that a trader must carefully watch his trades and maintain the margin needed. Liquidation may occur if you don’t. The market platform may request a margin call in situations where the market shifts against the trader; in that case, the trader must either increase their deposit amount or close out a portion of their position to reduce leverage.
Benefits and Drawbacks of Leverage in Crypto Trading
Every investing plan has pros and cons; leverage is no exception. Let’s learn about the benefits first. One main benefit is the increased profit potential. Leveraging can help traders to multiply their profit and attain a larger position in the market with small capital.
Secondly, it can help investors diversify their trading strategies by adding more investment options like staking. Moreover, it enables traders to increase market access while maintaining access to their resources for other ventures.
However, Leveraging has certain risks. Leveraging can increase the volatility of the cryptocurrency market, which is notorious for being extremely volatile and could result in substantial losses. Margin call and liquidation can add additional risks, as failing to respond can result in the liquidation of the position.
Lastly, using leverage can lead to psychological strain because the possibility of increased gains may cause rash judgment and impulsive dealing.
Leverage Trading Risks
Managing leverage risk is a crucial step to maximize profits. Start by taking lower leverage as it provides a larger margin for errors and less liquidation risk. Several risk management techniques can help assist in reducing losses.
One such strategy is to stop loss and take profit, which automatically triggers the sale of your position if the market moves against you. By diversifying your trades, you can spread risk and lessen the impact of losses. Maintain market awareness and get ready to respond to rapid pricing changes.
To make wise selections, it’s critical to continuously educate yourself on market evaluations and leverage trading tactics. You can protect your money and enhance the trading process by implementing good risk management tactics.