What is Leverage Trading in Crypto and How Does It Work?
As the crypto industry is booming over the years, more new traders are entering the market. Crypto allows investors to generate massive revenues once they command the knowledge to read the marketing tendencies and the backdrop influencing factors. However, while spot trading is simple and easy to comprehend, many may still struggle to comprehend leverage trading.
Leverage trading in crypto needs an intermediary broker to lend capital to a trader to make the transactions (buy and sell). Leverage Trading is also called Margin Trading. It helps the trader borrow funds to raise his investment capacity and bet on expanded profit. If the invested crypto goes as expected, the trader gains the maximized profit, but the loss will be huge if it goes adverse.
Here is a similar example. We usually purchase mortgages for cars or houses. If we only have $10,000 and we want to buy a $40,000 worth of a car, we need to take a mortgage. We may pay the down payment for $10,000 and borrow the rest $30,000 from the bank and pay back the money in the contracted terms with additional interest.
Companies also borrow capital for their investment, especially when there is insufficient capital. The borrowed money comes with augmented revenue since the company expanded its capital for investment. But if their investment didn’t go in line with their plans, they would bear more liabilities and fewer assets.
Let ‘s Move on to the Leverage Trading in Crypto
The notional amount decides trading fees and revenues paid/received in derivatives contract trading. If we pay the same fee for trading $20,000, why don’t we choose the higher leverage and put small margin? If the crypto we bought goes up as expected, we will get the maximized revenue; however, if the price goes downward, the risk will be accelerated. We might suffer from liquidation, which means all the money in our account will be deducted as the trading loss.
$2000 with 10x leverage: $2000 x 10 = $20,000
$1000 with 20x leverage: $1000 x 20 =$20,000
In leverage trading, if the trader’s position margin declines to the maintenance margin threshold, the trader will get a margin call or be liquidated. A trader could choose less leverage with a higher margin to avoid liquidation.
If the margin ratio is 2%, then the leverage ratio will be 1/2%= 50：1
1 * leverage ratio = margin percentage
1* leverage ratio = 2%
Then leverage ratio = 1/50
If the trading volume is $1000, then the margin user should put into trading will be $20.
Margin amount = Margin Percentage * Trading Size
$20 = 2% * 1000
Leverage means maximizing your purchasing power by borrowing money.
e.g., the trader did not use leverage in the trading, and if the trader investes in a crypto A $100 when crypto A is trading at $100. The trader purchases one, and the next day the crypto declines to $5; the user can sell the one crypto to take back his $5, or he can still hold it till it rises back.
Let’s make another example,
Let’s assume there is Crypto A is trading at $6000 in market price. We have $6000 for investment.
Suppose we bought $6000 of Crypto A in spot trading. If the price of Crypto A goes up to $8000 the next day, we could sell the crypto A and take the $2000 gain.
Suppose we bought a $60,000 contract with $6000 and sell them the next day when the price of Crypto A goes up to $8000; as we traded for 10x leverage, then the revenue will be multiplied by ten times, so if we sell, we will get the $2000 x 10= $20,000 income.
Suppose we traded $6000 of crypto A in spot trading. If the price of Crypto A goes down to $4000 the next day, we could sell the crypto A at $4000 and lose $2000.
Suppose we bought a $60,000 contract with $6000 and sold them the next day when the price of Crypto A goes down to $4000; as we traded for 10x leverage, then the loss will be multiplied by ten times if we sell, we will lose $2000 x 10= $20,000.
Therefore, leverage trading is a double-edged sword. If the market moves as expected, then the profit of leverage trading is satisfying; if it goes adverse, the risk will be amplified. We recommend that beginners start from spot trading, gather specific knowledge about crypto trading, and consider the leverage trading while the trader feels ready.
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