What is leverage trading?
Leverage trading in essence, is trading with borrowed funds and using your own money as collateral.
In layman's terms, leverage trading gives you the option to trade with more money than you actually have while risking only the amount on your account.
This means that trading with leverage makes it possible to earn profits from trading with anywhere between 2x to 500x of what you could normally trade with.
What is leverage?
So what is leverage?
Leverage is essentially a loan offered to you by a broker or exchange, a loan that you can use to buy an equity. Or in this instance, a crypto. Leverage is generally shown as a multiplier. For example 20x leverage means that you can trade with 20x more money than you have on your trading account.
The mentioned multiplier is the ratio between the money you have invested and the amount of money you can trade with after borrowing the extra money.
As such, as a trader, you can use leverage to increase your purchasing power.
What is margin?
Leverage and margin or leverage trading and margin trading go hand in hand.
One doesn't exist without the other.
Margin is capital requirement you need in order to make the maximum leverage trade.
For example, if a crypto exchange offers you leverage of 100x or 100:1, this means that you can trade with 100x more money than you actually have.
If you want to trade with $1000, the leverage offered is 100x, your minimum margin requirement is $10.
Leveraged Trading Example
Imagine you have $100 your account, but you are offered a leverage of 10:1.
This means that for every $1 on your account you can make a trade worth of $10. So the maximum amount of money you could trade with is $1000.
Note that you do not have to use the full leverage and it's actually smart not to do so.
But imagine you make a $1000 trade using as much leverage as possible.
If the crypto price goes your way 10%, you would earn $100, so essentially doubling your money. If you made the same trade without leverage, you would have have earned $10.
However, if the crypto goes price goes in the wrong direction 10%, you would lose your entire capital of $100. Had you made the same trade without leverage, you would have lost $10.
Why is trading with leverage good?
Leverage trading gives you more capital to trade with.
As a trader with only a small capital it makes it possible to earn from more money than you actually have.
Leverage trading risks - Trading with Leverage increases exposure
However, as you can imagine, there are no gains without risks and when it comes to leverage trading, the risks are great.
As you already saw, when trading with 10x leverage it takes only 10% price movement in the wrong direction to liquidate your assets.
And actually your position will usually closed sooner than you have lost all your money.
When your position is closed, depends on the exchange or trading platform. But normally your position is automatically closed already when your margin has fallen to 30%.
Most people who start trading with leverage always try to make as big trades as possible, meaning they also risk all of their money all of the time.
And considering most people lose money when trading on financial markets anyway, leverage trading makes it possible to lose all of your money even faster.
When should you trade with leverage?
Obviously we could find numerous good reasons for using leverage, but instead, let's bring out just two.
- Nobody should start trading with leverage right after getting started with trading. If you don't know whether you are capable of making winning trades, there's no point in risking more money than you have to.
If you can't make profitable trades without leverage, you can't make profitable trades with leverage either.
So before using leverage, make sure you have managed to figure out a profitable way of trading, and then, and only then, you should consider trading with leverage.
Otherwise you will wipe your account of all funds in the speed of light. - Leveraged trading helps to increase capital efficiency. Let's imagine you are capable to making profitable trades. Imagine you have $10 000 of free money to invest.
Now, you could trade with that $10 000, but that would mean you can't make any other investments. Instead, you could just use $1000 of it for trading, trading with leverage, and the other $9000 you could invest elsewhere.
But again, as mentioned, this too assumes you are a profitable trader.
How to trade with leverage
If you want to trade with leverage, you can find many options to do that.
These days leverage trading options are offered by pretty much every cryptocurrency exchange out there.
But not only.
You can also trade with leverage on CFD trading platforms and the leverage offered by these ones is generally higher.
One good CFD trading platform is Evolve Markets.
Pros and cons of trading with leverage
So what are the main pros and cons of trading with leverage?
Pros | Cons |
|---|---|
You can trade with more money than you actually have | You can lose all of your money really fast |
You can earn from that magnified trading capital | |
Makes it possible to earn something even in case of low volatility |
Conclusion
Leverage trading gives you more money to play with and you can sometimes make trades 100x bigger than your own capital.
This means that your gain from your $100 margin in case of a 10% price change can be $1000 while otherwise you would have earned $10. But you can lose your money even faster, should the trade go the wrong way. Your assets on the exchange or platform would get liquidated already before the price has changed 1% in the wrong direction.
So if you use leverage for trading, trade with caution and do it only when you know that you are a profitable trader.
