Trading with Leverage
How to trade crypto with leverage
What you'll learn
- What is leveraged trading
- An example leveraged trade
- Leveraged tokens
- The risks of leveraged trading
Trading cryptocurrency involves risk. There is no way to sugar-coat that message. Its riskiness is actually what attracts a lot of traders. Prices move significant amounts over very short periods of time, and traders see that volatility as an opportunity.
Take February the 8th, 2021 as an example. Elon Musk tweeted that Tesla had invested $1.5bn in Bitcoin, and the price increased by almost $8,000 in one day. From a low of $38k, that represents a 20% increase.
The event triggered gains in alt-coins which actually made 20% seem quite modest. Wild swings with the potential for huge trading gains can be very seductive, but though cryptocurrency is volatile, the Tesla inspired spike isn’t the norm.
There is however a way to trade which amplifies volatility, magnifying both potential gains as well as losses - so every day would be as dramatic as February 8th. It is called leverage.
Before we explain what leverage is, and how it works, it is crucial to understand that trading with leverage is like driving a high performance sports car. It can be exhilarating, but one mistake can spell disaster. So to extend the analogy, if you are just learning to drive (trade), you shouldn’t be using leverage, but sticking to a Prius..
What is trading cryptocurrency with leverage?
Leverage works through a cryptocurrency exchange or brokerage granting you the right to trade positions that are multiples of your trading capital.
You might for example have $1,000 of trading capital.
If you executed a regular (non leveraged) trade that realised a 10% gain you would make $100 (1,000*0.10) and end up with $1,100.
If the trade realised a 10% loss you would lose $100 and end up with $900 or 90%.
With x10 leverage you could execute the same trade, but your $1,000 would act as what is known as a Margin, and you’d effectively be trading with $10,000.
Now the 10% gain would translate into a $1,000 profit (10,000*0.10).
However, the 10% loss would result in you losing your entire trading capital - 100% loss.
Here’s that example demonstrated in a table.
|Long Position - 10% Fall||Without Leverage||With Leverage x10|
|Loss from Trade||€100||€1,000|
|% Capital Lost||1%||10%|
|% Capital Remaining||99% - €9,900||90% - €9,000|
|% Remaining Balance to Break Even||1%||11.11%|
Because of the way that leverage magnifies profit and loss, a leveraged trade will have a point at which unless you add more capital, your position will be automatically closed. This is also known as a Margin Call.
Leveraged trading is popular in markets with low volatility, like foreign exchange markets, because the fluctuations are fractions of a percentage. Despite the fact that cryptocurrency is inherently volatile - by comparison - leverage is available on some exchanges up to 100x, though multiples start at x2 or x3 and move upwards from there.
Trading with leverage is surprisingly simple for something that is so risky, but some exchanges have actually simplified the concept even further by creating leveraged tokens.
A leveraged token is just another way of amplifying risk but without having to provide collateral or consider margin levels. The price movement is simply magnified at an agreed level or range, and built into a new synthetic token version of an existing cryptocurrency..
Taking Binance Leveraged Tokens as an example they offer BTC UP and BTC DOWN leveraged tokens. If you buy BTC UP (x4) then you are essentially amplifying the percentage increase in Bitcoin’s price by 4:1; this is simply built into the way the BTC UP token functions.
The leverage isn’t however constant, but instead targets a leverage range from between x1.25 and x4; as Bitcoin’s price increases the leverage increases, then declines when the reverse is true in order to try to minimise liquidation. The reverse is true if you want to buy BTC DOWN.
Neither of the tokens can be withdrawn from Binance as they aren’t intended as anything but a trading derivative. On their own, leverage tokens would generally be used in short-term spot trading strategies, but could be held for longer as part of a more complex trading strategy hedging other positions e.g futures or options.
Mitigating Leverage Risk
As already mentioned, trading cryptocurrency with leverage amplifies risk, and should only be considered by experienced traders. Simply applying leverage and letting rip would be extremely reckless. The following basic tactics should be used to mitigate the risk.
The most important consideration with leverage trading (which applies to trading full stop) is not to put yourself in a position where you can lose a large proportion of your entire trading capital.
Losing large proportions of your trading funds from one failed leveraged trade - say 80% - might make you less inclined to maintain discipline in how you manage the remaining 20%.
Setting a stop-loss
Entering a leveraged trade should be approached in the same way as a regular trade - as outlined earlier in this section. You should have an entry point and exit point based on anticipated gain, but also a point at which you pull the plug and accept your assessment was wrong.
With leveraged trading this is called setting a Stop-Loss, and given the amplified risk is crucial to avoid unrestricted losses. Bear in mind, the ability to trigger a Stop-Loss exactly as required may be dependent on there being enough liquidity in the market.
The benefits of knowing without trying
Learn Crypto is dedicated to explaining basic concepts within cryptocurrency to people who are new to the subject. Given the level of potential risk leverage trading is something that really should be left to very experienced traders.
You might think that reading this article is a waste of time; that is far from the truth.
You may not be a skilled enough skier to ever attempt a black run but it is still important to understand the challenge and danger. It helps create a mind-map for the spectrum of risk involved in skiing and where you sit.
The same is true of cryptocurrency. The more you understand, the more you can make sense of news, sentiment and adoption.
March 12th, 2020 is known as Black Thursday, Bitcoin fell 50% within 24hours as the potential economic impact of the Covid19 pandemic instantly spread from the major stock markets.
This kind of dramatic event triggered a wave of liquidate leverage positions within crypto, and Margin Calls in other markets, with traders closing crypto positions to fund. This created a cascade effect. With Bitcoin dropping from a high of $7,648 to a low of $3,870.
“The traditional safe havens are struggling right now, possibly because the institutions are liquidating positions in these assets to fund margin calls in the equity markets. “
Where previously reporting of that kind of event from sites like Coindesk might have made no sense to you, by learning about subjects like leverage, you have the ability to absorb and understand what is happening from an entirely different perspective.