Leverage is a quick way to earn more when trading. With it, you can greatly increase your trading profit. Of course, it sounds intriguing; however, it is a two-edged sword that not only benefits but also causes a nightmare for many beginner cryptocurrency traders when not managed properly. For this reason, you need to know what leverage is, how it works, and how to manage your risk when using it.
What is leverage in cryptocurrencies?
Leverage allows you to get more exposure to the crypto market than the amount you deposit to open a trade. It’s more like using borrowed funds to open trades while providing only a fraction of the full value of the trade.
Traders and investors use it to increase the amount they hold in their wallets so they have more capital to trade with. Leverage is given by the broker or exchange you are using, and the amount of leverage usable for trading varies from one exchange and trading instrument to another.
How does crypto leverage trading work?
Leverage is usually represented in ratios. Exchanges typically offer leverage options between 1:1 and 1:500, and even higher. Using 1:100 leverage means you can execute a trade that is 100 times (100x) larger than your initial margin. The leverage ratio of a position is determined by comparing your total market exposure to your deposit, also known as margin.
So let’s say you open a buy position on BTCUSDT with $100. If the price goes up by 5%, your profit will also go up by 5%, which means you will have $105. If you use 10x leverage, your position will be multiplied by ten. So if you have a 5% raise, the result will be multiplied by ten (the leverage), which means you will have a 50% profit instead of the 5% you had without leverage.
On the other hand, if the trade goes against you by 5%, you will also lose 50% of that position, and if it goes against you by 10%, your position will be liquidated and you will lose your money.
Let’s explain it in another way. If you have $1,000 in your wallet and want to enter a $10,000 worth of DOGE/USD position, you can tap it 10 times, which means your margin will be multiplied by 10. However, if you have less than $1000, let’s say $ 500, you can also increase your leverage to 20x, and you will still be able to enter the $10,000 position.
As in the first example, trading with more leverage also means that your potential losses are amplified, and if the trade goes against you, you will lose much more than you would without leverage.
Ways to manage your risk when using leverage
Now that you know how leverage works, you need to manage your risk when using it. Below are ways you can do it:
1. Determine your risk per trade
Before you decide how much leverage you intend to use, you must first determine the percentage of your capital that you intend to risk per trade. Common advice from many expert traders is not to risk more than 3-5% of trading capital per trade, no matter how promising it looks. This is because no trade is ever certain, and excessive leverage will put your wallet balance at high risk if the trade continually goes against your prediction.
2. Use Stop Loss and Take Profit targets
Stop-loss and take-profit orders are types of market orders that help traders control the amount they make or lose on any given trading position. The stop loss helps to limit your losses when the price reaches a certain point that you have predetermined, while the take profit locks in your profit when the price reaches a specific point.
Stop-loss and take-profit orders will help you stay in control, no matter how bad the market conditions are or how high the leverage you are using. Think of a case where you have a risk-reward relationship; Let’s say you risk 2 percent of your account per trade, no matter how much leverage you use. Using a stop loss that stops the trade when the market goes against you by 2% keeps you in the game as the loss would follow as planned. If you don’t use a stop loss, a single bad trade can lose you a lot of money.
3. Keep a separate account
The crypto market is unpredictable; even with the best analysis, the market price could still go against your predictions. Therefore, it cannot always be accurate, so it is dangerous to leverage all the amounts you have in your account. Doing so can affect your emotions as you don’t want to lose your entire portfolio. For this reason, it is better to keep a separate account for leveraged trading by allocating a certain amount of your capital to it.
4. Try to take advantage of a simulated account
You cannot control the amount of leverage you use if you do not understand how it works. One of the best ways to understand how it works is by trying it out on a simulated account, as there is no risk involved.
Paper trading for a while will make you see how leverage works and with that you will be able to tell how much leverage you are comfortable using. A paper trading account or simulated trading account helps you trade a simulated account in the same way as you would a real account.
The leverage you use will affect your profits and losses in the same way as it would in a live account. So it can help you to know how much leverage you are comfortable with or if you are not even interested in using any leverage at all.
Leverage magnifies your profits and losses
Leverage can help you make more profit in a shorter time than the average trader who does not use any type of leverage. In the hands of a skilled and risk management conscious trader, it could be a reasonable advantage. It is very risky and can lead to significant losses and even account liquidation for careless traders.
The effect it can have on your account is tremendous. To do this, it is necessary to take your time to understand how it works and make sure that its use is always controlled by applying the advice that we have given you.