What Is Crypto Leverage Trading?
Leverage crypto trading in is a way of using borrowed funds to trade cryptocurrencies with more capital than initially invested in the trading account.
Trading crypto with leverage increases the buying power for the investor where he or she is able to multiply profits from 2 times up to several hundred times depending on the leverage ratio used.
This is a style of investing where the investor borrows funds from the exchange in return for a fee. When you make a profit, your wins are multiplied by the leverage ratios you use. This also applies to your losses.
What is leverage in crypto trading?
Leveraged trading in crypto can be very profitable once an investor enters the market at the right moment but at the same time, it can be a very risky endeavor as the margin capital put down to trade always acts as risk capital.
In this article, we are going to go in-depth explaining the full definition of leverage in the crypto markets, how it works, when to use it, all the costs, and all other important factors to think about.
Leverage trading crypto is legal in the USA and many other parts of the world but some nations have different regulations that brokers need to abide by to promote their services legally.
How trading crypto with leverage works
Crypto leverage works the same way as it does in other financial markets where you need a broker that offers derivatives trading such as CFD, ETF, Swaps, or Futures. These contracts carry leverage that will increase your position size. The only thing you need in order to access leveraged products is the initial margin deposit which can either be deposited as cryptocurrencies or fiat currency. Once your initial margin is in your account you are free to choose from all the different products that are offered by the operator and open positions your chosen coin.
The added buying power you get on a crypto leverage trading platform comes from backup funds that the platform owner provides. These funds are not yours to keep and you will only have access to them while you have an active position open in the market. Once the position is closed, the borrowed funds are returned to the broker and the difference in profits and losses are split among you.
What the broker earns is the trading fee which is also increased due to the increased position size, you can read more about fees and commissions further down on this page. When you make a profit with a leveraged position in crypto you either earn profits directly in the coin you are trading, for example, XRP, or you will get rewarded USDT which is a common stable coin that many exchanges pay out profits in.
How to trade crypto with leverage
Opening a trading account and accessing leverage is a piece of cake and almost anyone can do it. Some exchanges will ask for your KYC documents and some won’t, however, I would always recommend trading with a broker that asks for your documentation due to security reasons. Only you can supply the correct KYC documents in case of theft or a hack.
Now, there are several great options for beginner traders to use but no matter which platform you start out with I recommend beginning at lower leverage ratios to learn how the game works. The results from trading with leverage will show effect immediately and the swings in your account might be a little bit shocking as big profits can turn into large losses in a matter of minutes or even seconds. If you are completely new to this style of investing here is a step-by-step checklist you can follow to get started:
- Choose a reputable crypto derivatives exchange.
- Create an account.
- Send in your KYC documents for identification.
- Make your first deposit either in crypto or fiat currency.
- Select the coin and trading pair you want to trade.
- Choose the amount you trade.
- Select the leverage you feel comfortable with.
- Click Buy.
This is a very basic guide to how to get started but it is essentially true for all crypto platforms you will encounter and now it’s time for you to get down to doing some sound research before you increase your size. A great way to make good predictions of the market is to make a technical analysis of the coin you are trading and base your next position on this analysis.
Managing risks in leverage crypto trading
There are some not-so-dangerous risks about leverage crypto trading and there are some risks that can end in you losing all your capital, let’s break it down so you can avoid the biggest pitfalls. Below is a list of the most common risks of using leverage while investing in digital assets:
- Difficult to understand
- High fees
- Unexpected losses
- Margin call
If you are aware of these risks and avoid the most important mistakes you are going to have a safer journey to your goals while investing in derivative products or futures markets. To learn more, read our guide on risk management while trading crypto with leverage.
Difficult to understand – The reason why I highlight this as a risk is that many times beginner traders can get caught off guard when they first use borrowed funds to trade with. First of all, you need to be able to calculate your leverage ratios correctly to know how much capital you are using. Second, the platforms that offer this style of investing a usually a little bit more complicated since there is another dimension to the investment process. Make sure you understand what you are doing and how all the moving parts work before you start.
High fees – This is a risk that is not obvious to new investors but it can slowly eat your account and indirectly make you lose money if you are not cautious. Without knowing it, you might be paying $10 or even $50 per opened position if you are using leverage ratios over 1:20. This can pretty quickly result in large losses for active day traders that open 10 – 100 positions per day. Many exchanges also charge an overnight fee if you keep your positions open longer than 24 hours.
Unexpected losses – The crypto market is volatile as it is, but with added buying power the amount you stand to lose and the speed of loss can become almost uncontrolled if you are unlucky. Some positions that start out well can turn sour in an instant and you may lose hundreds of dollars in a matter of seconds if you are not paying attention.
Margin call – A margin call is a risk to your whole account. When you get margin called, your exchange is telling you that your losses have almost grown too big for your account size and if you take on more losses you will lose all your funds or more. This is the warning sign that you have taken on too much leverage for your own good. Scale down and start over.
Liquidation – Liquidation is every crypto investor’s nightmare. Liquidation happens after you get a margin call and you did not act properly. When your losses grow bigger than your margin account balance your exchange will force close all your open positions which will result in a total loss of all your trading capital. You have to pay back leverage in crypto and if you get liquidated all the funds in your account go to pay the loss.
Pros and Cons of Trading Crypto with Leverage
Let’s go through the real benefits and drawbacks of investing in cryptocurrencies with increased buying power, after all, there are two sides to this coin. Depending on how you view the markets and your investment approach you will have different benefits from using leverage. Now, simply listing all the pros and cons without explanation will do not be good, so for each point, I have added a small description to let you know how I see these good and bad aspects.
Multiplied profits – This is the true benefit of a leveraged crypto trading account. The possibility to make 2, 5, or even 10 times more money each time to make a profit is the main reason why traders and investors choose this style of investing. The crypto market is volatile as it is and when you add extra buying power to the mix you can make outstanding gains if you know how to control your risk.
Trade more effectively – This is an aspect that many traders forget as they focus mostly on making money. When it comes to investing money in a good market you want to be able to squeeze the profit of a good setup. The perfect setups don’t come often but when they do you want to maximize the profit by using leverage.
Grow your account faster – One of the biggest struggles of a new trader or even an intermediate-level trader is that they can’t get their account to grow fast enough. I’m not saying that leverage will take you from a $500 account to a $250,000 account in no time but it will enhance the effect of your profitable trades and give you more capital to work with faster.
Trade more coins – This is a given benefit why when using leverage for investing in digital assets. Only by using a ratio of 1:10, you are able to spread your risk and include more coins in your portfolio.
Risk less money per trade – Here is another forgotten benefit of leverage as most investors only see the other side of the trade, the profits. But, when investing with leverage you can reduce your own margin (risk capital) per trade and risk less money per investment. If you keep your ratio between 1:2 to 1:5 you can still have a decent liquidation level from 50% to 20%.
Unlimited losses – This is not a problem with all exchanges and all brokers but some leveraged trading platforms have a risk where you can pretty much lose more than you have and this is a serious issue. Always check with the broker you trade with that they have negative balance protection. What happens when you lose on crypto leverage is a little bit different from forex and stock trading since crypto exchanges normally has built-in negative balance protection.
Go in debt with your broker – Touching on the previous point, you can go in debt with your crypto broker if they don’t have negative balance protection that stops your account balance from going into negative. The worst-case scenario is that you forget to add a protective stop-loss order and your position goes against you during the night and you wake up with a $25,000 debt to your broker.
Underestimate leverage – Most new investors underestimate leverage, especially if the first few trades make a profit. New investors normally add extra leverage to their positions after a few wins discounting the effect of high leverage crypto trading. Switching from a margin ratio of 1:5 to 1:20 has a tremendous effect on your liquidation level and you can get wiped out in a heartbeat if you are not careful. See some of our high leverage trading strategies which can also be applied to cryptocurrency.
Become greedy – This happens to nearly every investor as they try investing with added buying power for the first time. The illusion of making consistent large gains tricks the investor into thinking that this is easy and the over-trading begins.
Overtrade – Once an investor or trader realizes how much money there is to be made with more capital there is a big chance that they fall into overt trading due to the search for quick success. They realize that they are only one or two trades away from a huge win and they chase this profit potential trade after trade without realizing that the increased position size adds a higher fee that quickly eats up the trading capital.
Crypto leverage ratios explained
Crypto leverage ratios are best understood if you think about a position in two pieces, your part, and the borrowed funds that your cryptocurrency exchange provides.
Your part is the margin capital you add to open the position and the rest is the full leverage ratio of the position.
For example, if you open a position with 1:2 leverage you will open a position that is two times bigger than your current account balance. In this case, you will pay 50% of the full position. Should you increase the leverage ratios to 1:4, which means that you are opening a position four times bigger than your account size, then your own margin ratio will be 25% of the full position size.
The calculation of leverage ratios in cryptocurrency goes on like this and to explain things further I’ve included a table below with the most common ratios of both margin and leverage. Check the table to see how much of your own capital you need to add for each leverage ratio.
The total margin capital for each leverage ratio that you have to add to the total position size is written in cursive script.
|Leverage ratio (Margin ratio)||1:2 (50%)||1:4 (25%)||1:10 (10%)||1:20 (5%)||1:50 (2%)||1:100 (1%)|
|Total position size|
As the ratios become higher the margin requirements shrink and if you trade crypto with a 1:100 ratio you can open a position of $10,000 with only $100. Keep in mind that this is not a recommendation as investing with a 1:100 leverage ratio gives you a 1% liquidation level. This means that if you open a position with a 1:100 ratio you can only afford a negative movement of 0.99% before you are completely wiped out.
How to calculate leverage in crypto trading?
There are two things that you will find out by calculating your leverage when trading cryptocurrencies. First, your margin requirement, or how much of your own capital you need to put down to open a position. Second, your maximum position size.
These are the two essential leverage calculations that every investor needs to know before getting started. Today, you will learn the simple ways to do this calculation in no time so that you can quickly figure out how much money you need for each position and how big the position size will be for each leverage ratio.
I will use two tables to describe these calculations. The first table will be on how to calculate the margin requirement for your position and the second one will be to calculate the maximum position size depending on your ratio and your current account balance (margin capital).
This table will help you calculate how much of your own account balance (margin capital) you need to put down to open the position size to the left using different leverage ratios from 1:2 to 1:125. Your required margin capital is written in cursive script. To make your own calculation, follow this example:
Position size / Leverage ratio = Margin requirement
When you look at this table it’s obvious what kind of effect leverage has on the calculation of your margin capital. When opening a position size of $75,000 with a leverage ratio of 1:125 you only need $600, but to open the same position of $75,000 with a leverage ratio of 1:5 you need to add $15,000 from your own account balance.
In this next table, you will see how we calculate the different position sizes depending on the account size (margin balance) from $200 to $12,500 with different leverage ratios from 1:2 up to 1:125. This is an example where we assume that you are going to maximize the account size and use all your margin balance in each position. To make your own calculation, follow this example:
Account size x Leverage ratio = Maximum position size
|Account size (margin balance)|
This table shows the true power of leverage. To be able to open a position of $25,000 with only $200 in your account gives you plenty of buying power and with an account size of $12,000 you can open a position size of $1,500,000 if you use 1:125 leverage. Keep in mind that these levels of leverage are very difficult to trade with and very risky. The reason why the risk is so high is that your liquidation level shrinks to less than 1% when using ratios over 1:100.
What other traders ask
It’s a type of investing where you use borrowed funds from your trading platform to access more capital and open bigger positions.
If you are a beginner trader and want to try it out I recommend that you start with low ratios of 1:2 or a maximum of 1:5.
The same thing happens to a leveraged position when you lose money. The only difference is that your maximum position is bigger and your losses might be bigger.
5x leverage means that you are borrowing five times the money in your trading account from your broker. If you currently have $1000 in your account, 5x leverage would give you access to trade with $5000.
For experienced traders that have a strict routine and strategies, it can be a very good addition to your wins where the added buying power will increase your profits.