For investors, Contracts for Difference (CFD) offer a variety of trading options in different global markets. One of the most widely used CFD methods by traders is leverage.
Leverage in crypto trading is considered the best opportunity to multiply profits. However, leveraging is still not free from the risk of loss. In this article, we will explain what leverage is in crypto trading and how it works.
What is Leverage?
Leverage is a strategy in which investors use loan or debt capital to increase the potential return on their investment. This step aims to multiply the potential profits derived from a crypto trade. However, leverage also increases the risk of loss if market price movements do not match predictions.
What is Leverage in Trading?
Leverage in trading occurs when traders increase their investment position using various trading instruments such as futures contracts, option contracts, and margin accounts. The aim of leveraging is to increase the potential returns on their investment.
What is Leverage Ratio?
The leverage ratio is a strategy used to compare a trader’s initial capital with the value of the assets obtained after using leverage. Brokers usually offer different levels of leverage ratios to investors. Below are two examples of leverage ratio levels:
This level of leverage ratio means that for every $1 of capital, traders can trade assets up to $100 in value.
With a leverage ratio of 1:3000, traders can trade assets worth up to $3000 with a capital of $1. This high leverage in crypto can be very profitable for those with small capital.
How Does Leverage Work in Trading?
For example, let’s say you’re interested in buying bitcoin assets on a crypto exchange or broker because you see extraordinary opportunities. However, the funds you currently have are only $1000, even though the bitcoin you want is worth more than $1000.
The solution is to borrow $9000 from the exchange or broker in question. That way, you now have $10,000 in funds which can be used for crypto trading according to the desired amount of exposure.
In terms of the leverage ratio, this means that with an initial capital of only $1000, you can still buy bitcoin assets worth $10,000. This translates to a leverage ratio of 10x or 1:10.
Nevertheless, this strategy involves a significant level of risk. For example, if the price of bitcoin moves by $10, since you are trading at 10x leverage, the move will have a value of $100. In other words, you will get ten times the impact of the movement, whether the asset price is rising or falling.
However, there’s no need to worry. If you apply this strategy carefully and plan carefully, it is possible for you to earn significant profits. The key is to learn and understand crypto asset technology, along with trading tips and tricks.
When is the right time to use Leverage Trading?
Leverage offers a practical option when you don’t have enough funds to buy a large amount of equity, even for assets that can be worth up to $50,000 in the crypto market.
For example, if you want to buy bitcoins for $500, but you only have $100, you can use the following leverage options:
Leverage 5X: $100 x 5 = $500. So you can buy $500 worth of bitcoins for just $100.
Leverage 10X: $100 x 10 = $1,000. So you can buy $1,000 worth of bitcoins for just $100.
You can also use higher leverage to buy bitcoins with less capital.
With 10X leverage, $100 becomes $1,000 and with 20X leverage, $50 becomes $1,000.
However, it’s important to consider the risks involved in using higher leverage. While it can lead to high profits if the price of bitcoin rises as expected, it can also result in the loss of all your funds due to liquidation if the price drops.
Without leverage, even if the price of bitcoin drops from $100 to $1, you can still recover some of your investment by selling or holding the bitcoin. But in leveraged trading, if your margin falls below the maintenance margin threshold, your trade may receive a margin call or be liquidated.
To minimize the risk of liquidation, it’s advisable to use lower leverage, which requires a higher amount of margin. This provides a buffer against sudden price drops, increasing the chances of retaining your investment.
You could say leverage is a double-edged sword. On the one hand, leverage can help increase your investment. However, the risk of loss is also quite high. The use of leverage can be satisfactory when market movements are as expected. But if the opposite happens, you have to be prepared for potential losses that are not small.
What is the difference between Spot trading and Leverage trading?
Spot trading is an activity that refers to buying and selling trading assets, such as financial instruments, foreign currency, commodities, or crypto instantly at a certain time. Generally, settlement of spot trading transactions is carried out using the T+2 system (trade date plus 2 days). This means that the transfer of assets between the seller and the buyer must be completed no later than two working days after the transaction occurs. This system is applied to track price changes in the spot market which always occur very quickly.
This is different from trading leverage, where traders can borrow funds from a broker in advance to increase capital when trading. This loan capital is used to buy a number of assets in the trading.