Advanced stock traders use leverage frequently to improve their ROI potential. However, it wasn’t until recently that cryptocurrency trading platforms began to offer this feature to users. Nowadays, you can find a variety of CEXs (centralized exchanges) and DEXs (decentralized exchanges) that offer these services to the market.
So what is leveraged trading and why is it such a valuable tool in the hands of a professional trader? When is the right time to use a leveraged trade and what are the risks of doing so? Here’s some valuable insight into how leveraged trading can help you to improve your crypto strategy and trading results.
What is Leverage?
Leverage is a term used to describe the act of borrowing funds from a broker to improve your exposure to a particular market. When you leverage trade you ask a broker to provide you with more of the investment you desire. The goal of these actions is to increase your profit potential or obtain access to a high-value asset that would otherwise be inaccessible.
Leveraged trading has been in use for many years in the stock market and operates in the same manner for crypto traders. It is usually written as a ratio or multiple. For example, your exchange could list leverage as 1:10 or 10x. They both mean the same thing, that you can trade with 10 times the amount you have currently. For example, you can control $10,000 in assets for $1000.
Notably, there are some regulatory restrictions on how much leverage you are allowed to access. For example, stock traders are limited to 5x leverage. Crypto leverage is usually lower at around 3x. Additionally, most platforms that offer these services provide some form of a leverage trading calculator to simplify your workload.
When you close your leveraged position, you must repay the broker his loan plus interest. You keep the difference as your profits. Notably, leveraged trading opens the door for many different types of trading strategies to be employed.
Problems Leverage Trading Eliminates
Leveraged trading helps to alleviate some serious concerns that have ailed traders for years. For one, leverage enables you to magnify profit potential. For day and swing traders, using leverage enables them to secure more returns as their technique requires them to secure profits on miniscule market swings throughout the day.
Another major issue that leveraged trading helps to alleviate is restricted access. There are many times when you need a minimum amount of capital to participate in a particular trade. In the stock market, this is very common. For crypto traders, this scenario could include gaining access to a particular NFT (non-fungible token).
Risks of Leverage
Leverage trading brings along some benefits but it’s not without risks. You shouldn’t trade with leverage until you are confident in your results as it can open you up to increased risk exposure. Leveraged traders must consider that their actions amplify both their risk and reward potential.
Another important factor to consider is fees and interest payments. These items can eat away at your trading profits. Since leveraged trading is still only available on a select few exchanges, it’s common to pay a decent amount of interest on these short-term loans.
Using Leverage in Your Trading Strategy
There are a lot of different trading styles in use today. Each of these types of traders can integrate leveraged trading into their strategy to improve their results. Here are some examples of ways you can utilize leverage trading in the market today.
Day traders are the most active types of traders in the market. A day trader will conduct many trades per day with each securing a little profit on each movement. The advantage of this strategy is that all of these little gains add up by the end of the day. Also, this approach reduces risk as the trader is never in a position too long.
Day traders can amplify their winnings using leverage. For example, you could use 2:1 leverage on a $1000 Bitcoin trade. This would provide you with $2000 worth of Bitcoin to trade. You simply purchase right before you predict a rise in value. Set your limit order to sell your coins when they hit your profit margin.
The main thing about swing trading is that it’s small market movements, so you need to set your limit accordingly. If you set your limit outside of the day’s price swings, there is a great chance you will miss the upswing trade out and end up breaking even or losing. To avoid this scenario, you will need to monitor the market closely for a few days.
Day traders are the next most active type of trader. These users conduct only a few trades a day. Since they are less active than swing traders, it’s vital that they capitalize on their daily activities. Leverage enables day traders to amplify results without increasing their trading activity.
Shorting is a term used to describe when a trader bets against a certain asset. Shorting is hugely popular as it enables traders to profit on price drops. The process of shorting requires you to take out a leveraged position on a particular asset. The goal is to acquire the asset prior to a major market downswing.
Once you have the asset, the first step is to sell it. The goal is to then wait until the price drops and repurchase the asset for much lower than your original trade. You then repay the broker or lender and keep the difference. When done correctly, shorting is a great way to secure some sizable returns.
Risks of Leveraged Shorting
Leveraged shorting is one of the riskiest ways to trade crypto. The main risk you face is if you sell the asset and the price of it rises, you then have to buy the coin at the new price to repay the loan. In some instances, this can be a major price difference. When this scenario occurs, it’s called a short squeeze.
One of the best examples of short squeeze recently occurred on the GameStop stocks. In this scenario, a group of Redditors noticed that hedge funds were naked shorting a variety of stocks. Recognizing that they would have to repurchase at any price, the group, called Wallstreetbets/r organized and began to purchase the stock.
In the end, they created such a massive short squeeze that brokers suspended purchases of the stock in a bid to protect the hedge funds who are their major clients. These actions resulted in an uproar from investors and regulators. It also helped to drive more stock traders to the blockchain sector as they are less influenced by centralized firms and brokers.
Advanced Trading – Starts with Practice
One of the best ways to practice your leveraged trading strategy is to open a dummy account on an exchange. Many platforms offer practice accounts. These accounts provide a way for you to test your leveraged trading strategies using real-time market movements.
The main thing to remember is that leveraged trading is only for those who are confident in their abilities to produce consistent results. As such, you need to take your time and DYOR (do your own research) when learning how to trade cryptocurrencies using leverage.