A Guide to Leverage Trading
Leverage trading is a powerful tool in the hands of experienced crypto traders. Is it different from margin trading? If it is, how?
Read our guide to leveraged trading to get all of your questions answered.
Introduction to Leverage Trading
Trading means buying and selling assets with the aim of making a profit.
Institutional trading looks at buying and selling stock, shares, and fiat currencies. Since we’re here for all things crypto, trading virtual currencies means buying and selling digital assets. Although the tradable assets differ, the purpose remains the same in both worlds – getting a return on your original investment.
What is Leverage?
To better understand leverage trading, we need to start with the very basics.
Leverage is an investment strategy that implies using borrowed funds to amplify returns from an investment. In other words, you borrow capital – or take on debt – to potentially make an investment.
Traders mostly use leverage to increase their buying power in the market.
What is Margin?
Margin basically refers to the assets borrowed from a third party to make an investment. So, buying on margin literally means borrowing funds to buy assets. What is Margin Trading? sheds more light on the history of margin trading and its underlying principles.
To clear the confusion, leverage refers to taking on debt, whereas margin is debt used to invest in other financial instruments, such as cryptocurrencies. The two terms are very similar yet different. The main difference is that margin is expressed as a percentage deposit required, while leverage is expressed as a ratio.
The terms leverage trading and margin trading – and their many variations – are mostly used interchangeably. Margin trading uses exactly the same principle as using leverage. In fact, it is margin that’s used to create leverage.
What is Leverage Trading in the Crypto World?
Leverage trading is a practice that allows trading assets by using additional funds provided by a third party. Leverage accounts give traders access to more capital. This means that traders can leverage their positions. In essence, leverage trading strengthens trading positions, and traders can realize larger gains on successful trades.
As mentioned above, traditional markets fund leverages by using an investment broker. What about providing these funds in the crypto market? This is usually done by other traders. Their motivation is to earn interest on the funds borrowed for leverages. In some cases, the exchange is the party that provides leverage funds to traders.
Short vs Long Positions
Now that you’ve learned the basics of what leverage trading is, let’s get a little bit more technical.
Leverage trading is quite universal. This means you can use it to open short and long positions.
Traders use a short position when they predict that the market is going to move down. Basically, they are betting against an asset instead of for it.
A short position often turns a temporary decrease to the trader’s advantage and can be used with or without leverage. For example, a trader believes the crypto market is heading downwards. S/he predicts that the price of bitcoin will experience a major decline. So, the trader decides to short it by using leverage. Therefore, s/he borrows funds to amplify the trade and sells BTC. In case the predictions were correct, the market begins to decline, i.e., the price of bitcoin drops.
The trader can now use the profit s/he made from the trade to pay back the leverage and the fees and buy back more bitcoin.
On the other hand, traders use a long position when they believe that the market is heading towards an increase. They either bet that the price of a certain asset or the entire market will continue climbing. Consequently, the profits are made from the price appreciation and selling at a later date.
How to Mitigate Risks in Leverage Trading
Being a financial activity, any kind of trading involves risks. As such, it is important to know where you stand to make the right decision.
Leverage trading is riskier than regular trading. This is because traders take on debt to make an investment. So, the borrowed funds need to be returned along with interest. Cryptocurrency prices can be wildly volatile, that is why it’s crucial to take some safety precautions.
Knowing the market and having technical analysis skills will not eliminate the risks completely. However, they will give you a much steadier base for leverage trading. We have prepared a few tips that come in handy when engaging in leveraged trading.
Understand the Terms
This is a basic but very important guideline. Make sure you clearly understand the terms and conditions of the exchange platform you’re using. This includes the fees charged for the trades.
Look for a platform that is transparent and clear in explaining their policies. Start by looking at their landing page. It should mention the maximum leverage and the obligations that come with trading. If you need more information, reach out to their customer support team.
Start out Slow
Leverage trading offers much higher potential gains than regular trading does. Sounds very tempting, right?
Just keep in mind that higher profits come with higher risks. Consider starting out with a smaller leverage, such as 1x or 2x, before going all in. It will help you get to know the leverage trading market, and you can gradually increase your risk. This approach also decreases the chances of automatic liquidation.
Know Your ABCs
It is very helpful to know the fundamentals of crypto and leverage trading before jumping onto it. This includes everything from technical analysis to trading tools. A strong foundation helps traders recognize opportunities, keep emotions out of their decisions, and mitigate losses.
Where should I start? Learning about technical analysis is a safe bet. Understanding technical analysis will certainly help you understand the market. Ultimately, it will mitigate your risks when leverage trading.
Get the Right Tools
Technical analysis can be hard to grasp at first. Especially, if you are just getting started with crypto. This is why traders need the right day trading crypto tools to help them with technical analysis. Some of the most important crypto tools are indicators.
Trading indicators help traders figure out the price direction of an asset. They are helpful in both long and short term price analysis. They signal the events that are bound to happen in the trading market. Trading indicators can measure a wide array of aspects: price movement, volume, momentum and other factors.
How to Start Leverage Trading?
We have covered the basics of leverage trading and how to mitigate risks. How to start leverage trading?
You can start by picking an exchange – not all platforms offer this type of trading. Equally important, there might be certain restrictions based on different factors.
Leverage trading offers also differ from one exchange to another. That is, the maximum leverage that an exchange offers, fees as well as trading terms.
Now that you know what leverage trading is, why not try it in practice? CoinMetro offers a leverage trading platform. There is an array of trading indicators and other handy tools available to help you with trading.