Leverage Trading in Crypto: A Beginner's Guide

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22 September 20226 min read

Is leverage trading good for beginners? What leverage is best for beginner traders? Is leverage trading profitable during a crypto bear market?

Leverage trading may seem confusing at first for beginner traders, which is why it’s crucial to understand the basics of trading with leverage and how it works. In the following sections, we’ll explore leverage trading, looking at how it works in crypto, entering short and long positions with leverage, the many benefits of leverage trading, a number of the risks associated with it, and a number of effective strategies for mitigating those risks.

Let’s get started!

What is Leverage Trading?

Leverage trading enables individuals to increase their investment positions by using borrowed funds. With a margin trading account, you can increase your leverage when trading in order to maximize your potential profits. As such, it’s an excellent way to realize significant returns, even (or especially) during a crypto bear market. But there is a downside of which investors should be aware: where there is reward, there is also risk.

Leverage uses borrowed capital to trade cryptocurrencies, increasing your buying power and allowing you to trade with more capital than you might have. Depending on the exchange that you use, leverage trading can also give you control of up to 100 times the amount that you need to open, helping you to maximize your potential profits and minimize your losses.

The amount of your leverage is called a ratio, such as 1:10 (10x) or 1:20 (20x). It indicates the amount of times your starting capital gets multiplied. For example, you would only need $1,000 to invest $10,000 at a leverage ratio of 1:10. In leverage trading, substantially less initial capital is needed to generate the same amount of profit.

How Does Leverage Trading in Crypto Work?

Leverage trading in crypto starts with funding your trading account, and the initial capital you provide is called collateral. The required collateral varies depending on the leverage you choose and the total value of the position that you wish to open, which is called margin.

The first step in leverage trading crypto is to fund your trading account. The capital you invest is referred to as collateral, and its required amount varies according to the leverage you select and the total value of the position you wish to open (the margin).

For example, if you were to invest $1,000 in Bitcoin (BTC) with a 10x leverage, the required margin would only be 1/10 of $1,000. This indicates that the minimum deposit amount required is only $100, which will serve as collateral. If you use higher leverage, say 20x, your required margin would be a lot smaller at $50 since it is equivalent to 1/20 of $1,000.

Aside from the margin deposit, you need to set a margin threshold, also referred to as the maintenance margin. In order to keep your position from being liquidated, you will have to add extra funds to your account if the market swings against your position and the margin falls below the maintenance threshold.

Crypto Leverage Trading in Long and Short Positions

You can use leverage trading for both long and short positions. Opening a long position indicates that you anticipate an asset's price to rise. Opening a short position, on the other hand, indicates your prediction that the asset's price will decline.

Crypto leverage trading and long positions

The easiest way to describe crypto leverage trading and long positions is to begin with a concrete example. Let’s say that you open a long position on Bitcoin for $10,000 with 10x leverage. In this case, your collateral is only $1,000. With this position, you can get a $2,000 profit if the price of Bitcoin increases by 20%, an amount far greater than the $200 you would have earned if you had traded your $1,000 initial capital without leverage.

On the flip side, your position would be down $2,000 if Bitcoin’s price drops by 20%. With your meager $1,000 in collateral, a 20% drop results in the position being closed out before the 20% swing has fully occurred. In this case, you will be fully liquidated and your balance goes to zero.

Crypto leverage trading and short positions

Let’s assume in this case that you want to open a $10,000 short position on Bitcoin with 10x leverage. You borrow Bitcoin from someone else and then sell it at the current market price. Because you chose to trade on 10x leverage, you’ll have the chance to sell $10,000 worth of Bitcoin while only having a $1,000 collateral.

On the other hand, suppose you borrowed 0.25 Bitcoin, sold it, and the price of Bitcoin at the time was $40,000. In this case, you can purchase the 0.25 Bitcoin back with only $8,000 if the price falls by 20% amounting to $32,000, netting you a profit of $2,000.

However, if Bitcoin increases by 20% to $48,000, you would need an additional $2,000 to buy back the 0.25 Bitcoin. Since there is just $1,000 left in your account, your position will be liquidated.

What are the Advantages of Leverage Trading?

Its primary advantage is that leverage trading provides a way to trade an asset without having to pay its full price. A trader using leverage can gain considerably by using a smaller amount of money to acquire assets with a higher potential return.

Higher profits with leverage trading

When compared to conventional trading, you can make significantly bigger gains with a far smaller investment. You only pay a small fraction of the asking price for a position rather than the entire amount.

More assets with leverage trading

You can grow your assets with less capital if you are confident in your investment. By investing in a variety of assets rather than just one or two, you can make the most out of your money and maximize its potential.

More flexibility with leverage trading

Leverage allows you to trade more often and execute more transactions to maximize the return on your investment. Similar to momentum trading, leverage trading also allows you to profit more quickly from short-term price fluctuations thanks to your greater flexibility.

What are the Disadvantages of Leverage Trading?

Leverage trading has many advantages over conventional trading, but there are also some disadvantages about which you should know beforehand.

Higher losses with leverage trading

With leverage trading, the odds are decent that you will experience a significant loss at some point, which requires a keen eye to recognize. Leverage can be detrimental in the long run, particularly when the money market is struggling, making it more suitable for short-term trading.

Leverage trading can be difficult for new traders

Due to the high level of risk associated with cryptocurrencies, only very experienced traders may be able to fully realize the many benefits of leverage trading. Experience helps, but practice makes perfect. Unfortunately, the stakes can be quite high for newer traders.

Leverage trading and psychological traps

Newer traders frequently attempt to raise a losing position to recover their losses. It’s a trap that can ensnare even the best of us, since we’re working with borrowed money. However, it's crucial to maintain your composure, start small, and take short positions in order to avoid potentially costly mistakes.

How to Manage the Risks of Leverage Trading

Leverage trading is a double-edged sword that can dramatically increase both your profits and losses. Here are some suggestions for managing the risks of leverage trading and leveraging it to your advantage (see what we did there).

Leverage trading and a stop-loss order

If the market goes against you, a stop loss can save your assets. A stop-loss is a risk management strategy that is intended to automatically cancel a position at a certain price. Because it places a strict limit on how much you can lose, it is an effective way to safeguard yourself from damaging losses.

Leverage trading and a take-profit order

You can also place a take profit order that will close your position whenever the gains reach a certain amount. It is wise to protect your gains before the market conditions change since cryptocurrency is volatile.

Leverage trading and position sizing

You can avoid situations in which you could lose a significant percentage of your trading money by thoroughly planning out your position sizing. If you lose a significant percentage of your trading capital in one unsuccessful leveraged trade, you could be less motivated to practice discipline when managing the remaining funds.

Never risk more than you can afford to lose

Regardless of the effectiveness of your approach, leverage trading can turn against you quite quickly, which is why you should never invest more funds than you can afford to lose. In general, putting more than 5% of your crypto portfolio at risk is a bad idea. You would want to invest money that you can pay back in case your trade doesn't work out.

The Bottom Line

Leverage trading allows traders to start with smaller initial capital but still be exposed to higher profits. Consequently, leverage trading can also result in sudden liquidations, especially at higher leverage levels of up to 100x.

With the right risk management and a sound understanding of the mechanics of leverage trading, you can realize significant profits while simultaneously mitigating the potential risks involved. As with any type of investing, remember to do your own research, consider the risks, and never use more money than you can afford to lose.