What Is Leverage in Crypto Trading?

WhiteBIT
Published 17 November 2023
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What Is Leverage in Crypto Trading?

Cryptocurrency attracts the attention of people of different ages and skills. Today, there are many who are just starting to work in the market, and it is important to understand such a concept as “leverage.” In this article, we will overview leverage in cryptocurrency trading, how to leverage trade crypto, and what risks and advantages this tool carries.

What Is Leverage in Crypto?

Leverage is an instrument that allows traders to trade with borrowed funds and thus manage positions with more equity. This increases both potential profits and potential losses.

How Does Leverage Work in Crypto?

Trading with the use of borrowed funds is possible only after replenishing the trading account. The initial capital is called collateral or pledge.

Leverage is specified as a ratio, for example, 1:2 (2x), 1:5 (5x), and even 1:10 (10x). It shows how many times the trader’s position increases. For example, using a leverage of 5x allows you to control a position that is five times larger than your initial investment. That is, having $100 on the balance, a trader can open a position of $500 with a leverage of 5x.

It is worth noting that the trader’s losses are limited to the amount on his account. This means that the investor will not be able to lose more than he has on his balance.

Crypto Leverage Trading in Long and Short Positions

What is leverage trading crypto in Long and Short Positions? Trading with leverage opens up the opportunity to profit from both upward and downward price movements. Long and short — this is the name of two positions in leveraged trading.

Long — by choosing a long position, a trader buys an asset at a low price and sells it at a higher price. Thus, the profit depends on the difference in cryptocurrency price.

Short — a position where a trader makes a profit on the token or coin price decrease. Short works like this: to open Short the user borrows assets from an exchange and sells them at the market price. They expect that when the price falls, they will buy assets at a lower price, return it to the exchange, and profit from the difference.

Let’s see how to use leverage in crypto to trade Bitcoin. For example, you have 100 USDT, and you want to open Long on BTC with 10x leverage. The deposit (margin) in this case is 100 USDT, and the maximum amount to trade is 1000 USDT. A 15% increase in the price of BTC will result in a profit of 150 USDT (without fees), which is much higher than the 15 USDT profit of trading without leverage.

Let’s look at another example — you want to open Short on BTC. You have the same 100 USDT, and the leverage for your position is 10x. Then, you borrow 1000 USDT (100 USDT * 10) worth of BTC from the exchange and sell it at the market price. The prediction turns out to be correct, and the Bitcoin price drops by 15%. You buy back the BTC at a lower price and pay back the exchange. As a result, you are left with a profit of 150 USDT, excluding fees.

Margin Call and Liquidation

Leveraged crypto trading involves managing borrowed funds. However, whatever the trader’s losses on margin trading, they will never exceed the amount of his Collateral. In order to guarantee this, the crypto exchange operates a liquidation system.

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Liquidation is a forced closing of a trader’s unprofitable position. It is preceded by a margin call — a notification to the trader about the need to deposit additional funds to the Collateral balance to support solvency. Usually, traders receive a margin call in the form of a notification or an e-mail.

To better understand how liquidation works on WhiteBIT, you need to know two indicators: Margin Fraction and Maintenance Margin Fraction. The Margin Fraction is the proportion of equity (on the Collateral balance) to the amount of borrowed funds. The Maintenance Margin Fraction is the minimum ratio of equity that must be in the Collateral balance to avoid liquidation. On WhiteBIT, for each leveraging crypto value, 1x to 10x Maintenance Margin Fraction is equal to 2.5%.

For example:

A trader’s own funds are 100 USDT, and he uses leverage of 10x. That is, his available capital is 1000 USDT (1000 * 10).

Since the Margin Fraction value is the ratio of equity to the amount of borrowed funds, to represent the ratio as a percentage, we need (100/1000) * 100 = 10%. This means that 100 USDT is 10% of 1000 USDT.

The Maintenance Margin Fraction for 10x is 2.5%, which means as soon as the ratio drops from 10% to 2.5% — the position will be liquidated.

10% of 1000 USDT = (10/100) * 1000 USDT = 100 USDT

2.5% of 1000 USDT = (2.5/100) * 1000 USDT = 0.025 * 1000 USDT = 25 USDT.

In this example, liquidation will occur when the losses in this position exceed 75 USDT.

What Are the Benefits of Leverage Trading?

The use of leverage opens up new tools for the trader, like hedging and Short positions, but on the other hand, the investor must keep an eye on the Collateral balance to avoid liquidation of his positions. Let’s take a closer look at these risks and benefits.

  • High Returns

By attracting borrowed funds to increase the volume of his positions, a trader can get a more significant profit. However, it should be remembered that the same principle that increases profits also increases losses. Therefore, the use of leverage involves risks that must be carefully controlled.

  • Diversification Opportunities

Leveraged trading provides a unique opportunity to diversify your investment portfolio. Traditional investment strategies often require significant capital. In contrast, leveraged trading allows you to spread your risk across different assets and markets without requiring a significant initial investment.

  • Flexibility

Leverage allows traders to adjust their trading strategy to the ever-changing cryptocurrency market and choose between different levels of risk and profit potential. Traders can place risky trades and make big profits, or opt for a more conservative investment with 2x leverage.

  • Hedging Opportunities

Hedging is a tool for controlling risk by opening a position to counterbalance possible losses. For instance, you have a lot of Ethereum and you are afraid that its value might fall. Consequently, the loss in value of the asset can be offset by the gains of another position.

  • Short Selling

Short with a leverage in cryptocurrency trading provides investors with two main advantages. First, it’s an opportunity to capitalize on market declines: you sell a cryptocurrency you don’t actually own, and earn on the difference between the sale price and the purchase price, allowing you to profit when prices fall. In addition, a short position allows investors to hedge their long positions or spot investments.

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What Are the Risks of Leverage Trading?

  • Higher Losses

Although leverage increases profits, losses increase with it. Even a small unfavorable price movement can lead to significant losses. Risk management strategy, making trading decisions based on analysis, setting Stop-Loss orders, and limiting the size of positions helps to minimize risks when trading with leverage.

  • Difficulties for New Traders

Due to ignorance, a beginner can lose all his money during the liquidation of his position. Therefore, it is crucial to understand how leverage works in cryptocurrency leverage trading to gain experience through a thorough study of this tool and related concepts before delving into trading. It is important to know such characteristics as Margin Fraction (the ratio of equity to the amount of borrowed funds) and Maintenance Margin Fraction (the minimum ratio of equity that should be in a Collateral balance) to avoid liquidation.

  • Emotional and Psychological Challenges

Fear of missing out on potential profits (FOMO) and fear of losing capital often lead to impulsive actions and emotional trading decisions.

Greed and overconfidence also create danger. The potential to earn more can cause traders to open unreasonably risky trades. Leverage in cryptocurrency should be used only after a comprehensive analysis and application of risk management tools. This way, the trader will be able to maximize the benefits of his transactions and control the risks.

  • Increased Volatility

Volatility is an integral part of the cryptocurrency market. Traders who do not use Stop-Loss orders and other risk management strategies may find themselves liquidating positions due to sudden fluctuations in the price of the asset. Cryptocurrencies are often unpredictable, so you have to be prepared for rapid price changes and stick to your risk management strategy.

  • Margin Calls and Forced Liquidation

Leveraged trading introduces the concept of margin — funds that are used to secure trading positions. Thus, when losses start to approach the minimum percentage of equity in the position (Maintenance Margin Fraction), you may receive a Margin Call from the exchange.

If the amount of equity in the position falls even lower, it may lead to liquidation — automatic closing of the position to prevent further losses and to ensure fulfillment of financial obligations to other traders and the exchange.

  • Higher Fees

How to buy crypto with leverage profitably? Leveraged trading often comes with increased trading costs in the form of funding fees and trading commissions. Commissions and fees cut into profits, so it’s important to factor these costs into your trading strategy.

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WhiteBIT Exchange offers only 0.0585% daily leverage fees and 0.1% trading commissions.

  • Limited Control

Leveraged trading often involves a trade-off between extended positions and investment control. By using leverage, the trader commits to predetermined levels at which the position will be liquidated. Sudden price movements may cause a forced closing of the position. In addition, unlike spot trading, leverage includes daily commissions. With spot trading, you can hold positions indefinitely and carry unlimited losses. But in leveraged trading, fees can consume the body of a position if you hold it for too long.

  • Regulatory and Legal Considerations

Each region or country has regulations for leveraged cryptocurrency trading. These cover, among other things, differences in allowable leverage ratios, platform registration requirements, and taxation of profits. Ignoring or misunderstanding these legal aspects can lead to serious consequences, including fines or lawsuits.

How Do You Manage Risks with Leveraged Trading?

Setting Stop-Loss Orders

This type of order, when a certain price level is reached, bids to sell the asset at the market price. In this way, the trader can avoid significant losses and subsequent liquidation by closing the position with smaller losses.

Usually, Stop-Loss (SL) is set below the current market price for Long positions and above the current market price for Short positions. When the market price reaches the set SL level, the order is triggered, and the asset is sold at the current market price.

Position Sizing

A trader’s risk management strategy should include the size of the positions he opens. Allocating 100% of your capital to a single trade is an unreasonable risk. Traders should strike a balance between profit maximization and portfolio preservation. Thus, by carefully calculating the position size, one can avoid taking unnecessary risks even when using leverage. Of course, each trader determines the position size himself. However, one should not forget about the generally accepted rule of 1%: open positions, the size of which does not exceed 1% of the trader’s capital.

Risk/Reward Ratio

The Risk/Reward Ratio (RR) is a ratio that allows you to compare potential profits and possible losses on a particular trade. Simply put, this ratio helps to understand whether a trade is profitable or not. The level of risk is usually controlled by placing Stop-Loss orders.

Suppose you want to buy an asset at $100 and lock in a profit at $150, but you are also mindful of the risk and set your Stop-Loss at $75. In this scenario, your RR would be 1:2, which means that the potential profit is twice the potential loss.

Typically, traders tend to open trades that have an RR of 1:3, meaning that the profit exceeds the potential loss by a factor of three. It is important to note that profit targets and potential losses are not simply price levels where a trader places Take-Profit and Stop-Loss orders. Before doing so, the trader must perform a thorough analysis and confirm his predictions with analytics.

Diversification

Diversification involves spreading investments across different assets rather than concentrating all capital in a single transaction. It reduces the risk of catastrophic losses from a single unfavorable market movement. A diversified portfolio allows you to offset losses on one trade with gains on another, providing stability and reducing risk.

Hedging

Hedging is a strategy that involves opening a position in the opposite direction of the trader’s primary position. This technique serves to mitigate potential losses in the event that an investor’s analysis predicts an asset price movement that is inconsistent with their current trade. In such situations, the trader may open an additional position by capturing promising market movement in order to lock in profits and, therefore, balance potential losses from the original position.

Risk Management Plan

This plan should include a variety of tactics to mitigate risk and protect investments to reduce losses. It should regulate all aspects of trading, such as position size, number of trades per day, target profit levels, maximum losses per trade, circumstances for averaging positions, and more.

Proper position size management will prevent one trade from jeopardizing the entire capital. In simple words, these are the aspects of trading that make chaotic trading “in pursuit of the big score” a systematic endeavor.

Cross Margin or Isolated Margin

Using cross-margin means using all the money in your account to back open positions. In contrast, an isolated margin means that for each position, a certain amount of money is allocated to support the trade.

Only a cross-margin account is available to collateralize positions at WhiteBIT. This is a single account that contains all margin assets. When trading using cross margin, the profit from one trade can offset losses from other trades. At the same time, a loss from one trade may lead to automatic liquidation of all open positions.

Examining the Different Types of Leverage Trading Available in the Crypto Market

Margin Trading

It allows traders to borrow funds on exchanges and increase the size of their position, increasing both potential profits and losses. Margin trading allows for both long and short positions. Traders should be careful when trading on margin as there is a risk of liquidating positions.

Futures Trading

Cryptocurrency futures trading involves entering into an agreement to buy or sell a cryptocurrency in the future at a certain price and date. Trading futures contracts is beneficial because it allows traders to profit from rising or falling markets.

There are also open-ended futures contracts. These transactions have no time frame, but every 8 hours traders pay or receive a funder depending on the market situation.

Perpetual swaps, options trading, and other derivatives are also available for leverage trading, but they also require a throughout research and risk management.

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Example of Crypto Leverage Trading

Read a short instruction on how to leverage trade Bitcoin.

  1. Firstly, you need to choose an exchange. For example, WhiteBIT, where you can easily fund your account from your bank card. Create an account and confirm your identity on the exchange (KYC). Next, replenish your balance and transfer funds to the Collateral balance.
  2. In the menu at the top, select “Trade,” then “Margin,” and choose the pair you are interested in.
  3. On WhiteBIT, traders can open positions on the margin market with leverage from 1x to 10x. For example, your capital is $1000, and you decide to use 10x leverage, which allows you to open a $10,000 position.
  4. For example, you decide to buy $10,000 worth of BTC. If the price of the asset rises by 15%, you can sell the BTC, and your profit will be $1500.

Impact Of Leverage Trading On The Crypto Market

Volatility

Due to leverage, traders can increase the size of their positions, and this reinforces existing market trends. For example, during periods of panic and falling prices, investors can massively close margin positions, which will continue the price decline. Conversely, in times of a bull market, leverage provides an opportunity to increase positions and make larger purchases, contributing to rising prices. Investors need to be cautious and prudent in their decisions, taking into account the current market environment and the risks associated with leverage.

Liquidity

Liquidity is the speed and ease with which a cryptocurrency can be exchanged for another asset or national currency. Leveraged cryptocurrency trading increases trading activity, which, in turn, improves overall market liquidity.

Market Manipulation

The use of leverage in the cryptocurrency market has a significant impact on its dynamics. Leverage allows for increased trading volume, which in turn increases the influence of market participants with large capital. This creates situations where short-term price fluctuations are used by manipulators to artificially alter market dynamics, causing instability and impacting less experienced investors.

Increased Trading Volume

By raising debt to increase the size of their positions, traders who know how to leverage cryptocurrency significantly increase their trading volume. This can lead to increased liquidity, larger price movements, and greater interest in the market.

What is Leveraged Trading on WhiteBIT?

WhiteBIT offers various opportunities for margin trading, including flexible leverage up to 10x. The exchange also offers low commissions for leverage at any leverage ratio — as low as 0.0585% per day. And WBT native coin holders can enjoy discounts on maker trading fees of up to 100%.

In addition:

  • On WhiteBIT, the user can also use other assets on the Collateral balance. This allows a wide range of assets to be leveraged to secure all positions. However, margin weighting must be considered;
  • A leverage fee is only charged if the order is at least partially executed, which helps reduce unnecessary costs;
  • Unlike spot trading, when opening a leveraged position, there is an option to create an OCO (One Cancels the Other) order.

FAQ

Leverage ratios in crypto trading determine how large a position a trader can open in terms of available funds. They allow you to increase potential profits, but they also increase the risk of loss. In general, platforms offer different leverage ratios for crypto trading. On WhiteBIT, the maximum leverage for margin trading is 20x, and for futures trading is 100x.

The specific term depends on your strategy, the exchange or platform you choose, and the type of contract. Positions can be long-term (weeks, months), short-term (days, hours), or limited to contract periods in futures markets. For example, the WhiteBIT exchange does not limit the time to hold a position, but there are daily fees for borrowed funds or funding for the futures market.

To avoid liquidation, it is important to understand what is leveraging in crypto and how crypto leverage works. Forced position liquidation occurs when the ratio of equity to borrowed funds falls to a certain level. On WhiteBIT, liquidation of a margin position occurs when the equity portion of the position drops to 2.5% of the position volume. To avoid liquidation, you can use such strategies as risk management, Stop-Loss orders, hedging, and others.

By leveraged crypto trading, traders can multiply the volume of their positions and create larger orders. Consequently, the rapid movement of capital associated with leverage can affect market volatility.

Stop-Loss orders are a type of market order that places a Market sell order when a certain asset price is reached. Stop-Loss helps traders close a trade at a small loss to avoid large losses.