Crypto leverage trading is nothing new, and is almost as old as Bitcoin. The basic idea of leverage trading is that you borrow money to invest in an asset, typically for a short term — and it can be as short as a few seconds.
The asset price will typically change slightly over a short period of time. However, since the borrowed money was invested into a large sum of the asset, the small change in price would translate to a more significant change in value of the asset. Once the target value is reached, the trader can then sell the asset back, and return the borrowed money to the issuing exchange.
Using crypto leverage trading, someone with a starting capital of $100 can have the same purchase power with 100X leverage as a trader with $10,000 without leverage. Crypto leverage trading could broaden access to the crypto market, increasing the volume of the market, and that can lead to an overall positive effect on traders’ experience.
In summary: Leverage trading allows traders to make large gains from small price changes. However, in doing so, the traders put themselves in greater risk of losing a significant sum of their starting capital. Therefore, leverage trading, whether it’s in the stock market, or for crypto leverage trading, magnifies the risk AND reward for an open position.
Crypto leverage trading for long and short trades
Crypto leverage trading can be used for both long and short trades. As you may know, long trades will profit when prices go up, and short trades will profit when prices go down. But how does it work for both types of trade? Here’s a simple explanation.
If a trader expects Bitcoin to increase 1.2% in the foreseeable future, and they only have $1000 of capital, they could try trading without leverage. Without leverage, they could only profit $12 from the movement. Of course, this may be too small of a profit compared to the amount of effort of setting up and monitoring the trade.
Long positions
The trader can choose to 10X their potential profit by borrowing $9000 from the exchange (making a total of $10,000 for the open position). In a winning situation, 1.2% of $10,000 is $120 that the trader can keep, while the original $9000 can be returned to the exchange.
The process of borrowing, opening a position, and returning the leverage money is typically done automatically. They’d only need to enter the total amount to trade. If the amount exceeds their initial capital, leverage will be applied automatically to the open position.
Short positions
The above case is for long positions. For short positions, the trader essentially borrows $10,000 worth of Bitcoin, and then sells them in the market for $10,000 to open the position. In this instance, the price decreases 1.2%, which means the Bitcoin that was worth $10,000 is now worth $9,880.
To close the position, the trader must buy back the same amount of Bitcoin borrowed, but only this time at a 1.2% discount ($9,880). The borrowed Bitcoin is returned, and the trader keeps $10,000 – $9,880 = $120 in profit.
Crypto leverage trading in a losing trade
So far, we’ve discussed what happens when the trade is going great and we make a profit. What happens when the trade doesn’t go as we wanted? As we’ve mentioned before, leverage trading will magnify your rewards and risks. Let’s go back to the previous cases:
Losing long position
In the previous case, the trader opens a long position for a total of $10,000 with 10X leverage (same starting capital at $10,000). However this time, Bitcoin’s price didn’t increase 1.2%. Instead, it decreases 1.2%.
The total value of the position is now (100% – 1.2%) x $10,000 = $9,880. The trader may choose to close the position by selling the Bitcoin for $9,880, and then returning the $9,000 to the exchange, pocketing $880. This is a $120 loss from the starting capital, compared to the $12 loss the trader would’ve experienced if they haven’t used leverage.
Losing short position
The risk is also proportional for crypto leverage short trading. Let’s say the trader borrows 0.36 BTC. The trader sells 0.36 BTC for $10,000 (the current rate at the time of writing). Now, instead of the price decreasing, much to the trader’s dismay, the price goes up 1.2%.
This means that the value of 0.36 BTC is no longer $10,000, but $10,000 x 101.2% = $10,120. The trader needs to buy back 0.36 BTC, but requires $10,120, which is $120 more. From the initial selling trade (when they opened the position), they got $10,000.
From where will the trader get $120 to top off the remaining debt? Of course, from their starting capital. After closing the trade, they have $9,880 of capital remaining.
Can you go into debt by crypto leverage trading?
This is a common question, and the answer is, most likely no.
If you use a trading platform that’s highly automated, your trade positions will be closed before you can go into debt. Borrowed assets or capital will be returned automatically as your positions close. However, if you use a trading platform where you need to manually borrow funds and pay overnight fees (or interest), you need to be extra careful and monitor your gains and losses more closely.
Take the losing long position. A trader can keep the trade open in the hopes that the price moves back up again. However, the price continues to move against the trader, and at some point, the loss is very close to $1000 as Bitcoin’s price decreases to 10%.
Without leverage, Bitcoin’s price must completely go down to $0 for the trader to lose all $1000 of starting capital invested into Bitcoin. However, with 10X leverage, it takes a 10% loss to completely wipe $1000 of starting capital.
When this happens, the exchange forces the trade position to close. This event is known as liquidation, and it protects the exchange from further liabilities, while also protecting the trader from going into debt.
Safely trade crypto with leverage
As this is an introductory article on crypto leverage trading, it does not cover everything. We highly recommend that you check out articles about trading safely with crypto leverage in this blog. In these articles, you’ll learn how to calculate position sizes, determine stop losses, and placing multiple trades to decrease risk.
Read more articles by Blockcircle to discover new tips, strategies, and trading safety advice.
