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Margin & Leverage Trading Fundamentals – Understanding the ‘Leverage’ Concept

Today let’s discuss the potential risks of taking high leverage while trading. But wait, before we start, I would suggest all readers have a look at one of our last articles on Margin Trading. ‘Leverage’ in simple words refers to the choice of trading with a higher base using borrowed capital from the broker or exchange. But wait, this article isn’t to discourage you from taking leverage. Instead, if you do it wisely you can make some really good returns.

Basic definition of Taking Leverage

‘Leverage’ isn’t that bad as it gives the traders an option to trade a larger amount of crypto with a small amount of capital/margin. For example, if you take a 125x leverage on a $10 margin, you can place a trade of $1250 but wait there are risks involved as well. In this example, you can clearly say that out of that $1250, only $10 belongs to you, and the rest of $1240 belongs to the broker/exchange. The exchange makes money in form of a trading fee twice & if your margin is exhausted because of a reverse price action than you anticipated, the position will be closed & the money of exchange is saved.

Some experts warn for this downside as I mentioned above. In spot market you can only loose 100% of your investment if the asset you bought goes to absolute zero but in Margin Trading, the same is dependent on the leverage you’ve taken. Also, the gains can be in multiples if your estimation goes right but that doesn’t mean losses should be neglected. In general, I’m personally risk averse and I avoid playing short-term games with my money. But again, that’s my personal opinion, I’ve also known some friends of mine who make pretty good money with Margin Trading.

Why people & traders take Leverage?

You can’t make $1000 off from a $100 investment in spot market unless the price really shoots up to the moon. Similarly, you can’t loose $1000 off from a $100 trade in spot market. Either way, it helps people to do more with their trading capital by taking more risk. It is valued by expert traders as it helps them trade more crypto/stocks/assets with their trading capital.

Let’s take one more example. If a trader wants to buy 5000 tokens of crypto at a $2 price would only need $2500 with a 4x leverage. This allows him to place a larger order with less money. In addition to being a wise use of trading capital, it can also reduce risk or act as a hedge for other types of trades.

If someone decides to invest in 1000 tokens of crypto at $100 per token, he would need $100,000 worth of cash & all of the $100,000 would be at risk. Instead, he could decide to invest the exact same amount of capital he could do that with only $5000 and still gain the same profit or loss with a 20x leverage. In simple terms, he will make $1000 for every $0.1 change in price.

But what shall you do?

I’ll give my general opinion while ending this article. It may or may not sound fancy to you but this is my personal take on the concept of margin trading.

  • If you haven’t made gains earlier on spot market then it’s better to stay away from leverage trading at first. The concept is pretty much same except that you can make money by shorting on a crypto token.
  • Don’t take excessive leverage, not more than 2x to 5x at first. Doing so will not only help you save your capital but will also help you understand how things work here.

Finally, if you want to avoid it all-together then the best suggestion from my side would be to just do the thing which ensures you get a good sleep at night.

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