Using leverage or margin trading increases your buying power and possible profits if your trades are successful. You can borrow money and trade larger amounts than you would be able to if you only used your own funds to trade. However, margin trading can also increase the likelihood that you will lose all of your money or that your account will be liquidated in the future.
In order to trade with borrowed funds, a certain level of risk already exists. However, margin trading within the volatile crypto markets increases this risk exponentially, which is why crypto traders must be extremely cautious and learn how to use hedging strategies and other strategies in order to manage this risk. The fact is that even if you learn how to identify market trends and use technical analysis, you will still be at risk. Overall, trading cryptocurrency on margin offers day traders a very good opportunity to increase their profits.
How Leverage Trading Works
The way leverage trading works is that a trader will make an initial deposit to borrow funds. For example, if you wanted to invest $5,000 in a leveraged trade at a ratio of 1-to-10, you would only need to invest $500 to open the position. In order to use the lending platform, traders will have to keep enough funds in their accounts to use as collateral.
A trader can open a long or short position. A long position indicates that the digital asset will increase in value, whereas a short position implies that it will decrease in value. When you trade a short, you borrow Bitcoin instead of cash. In this case, if the price goes down, you buy the same Bitcoin and return the lenders’ Bitcoin to keep the profit.
When you execute a successful long position trade, the lender will release your initial cash deposit as well as your earnings. It is possible to lower your risk of liquidation by using lower leverage. If you lose the trade, the broker will liquidate your position and take your money. It is possible to use 100-to-1 leverage when trading on many platforms, but this isn’t always the best thing to do.
Risks of Leverage Trading Crypto
In spite of the fact that leverage can be a powerful tool for maximizing your gains, there is always a high level of risk involved when it comes to margin trading crypto. When you use a higher degree of leverage, it is important to remember that your margin of error will be smaller to reach your liquidation point if you use high leverage. There are times when a difference of 1% in price can be enough for you to be liquidated and suffer a massive loss of funds.
The crypto markets add another layer of risk because of their sometimes violent swings in both positive and negative directions. To minimize the risk you will face when using leverage, you can utilize a number of risk-management strategies. The best way to minimize your risk would be to never trade with more than you are willing to lose and to always take a profit.
A stop-loss is a risk-management tool that allows you to close your trade at a particular level if the market moves in an unfavorable direction. By trading with smaller amounts, you are able to keep your risk down and avoid using all your money in one trade, thereby retaining more funds and opening more trades. By utilizing a lower leverage, you are able to maintain more funds.
There are even Cryptocurrency Trading Platforms that offer negative balance protection as a risk-management strategy. Negative balance protection ensures that you do not lose more money than you have in your account. If you become unable to maintain your account’s equity as a result of the leverage, the lending platform agrees to absorb the loss.