Have you ever wondered how certain traders achieve substantial profits with what appear to be minimal investments in the volatile crypto world? The answer frequently resides in a crucial financial tool: leverage.

Leveraged trading in crypto can be compared to a magnifying glass, accentuating both potential profits and losses.

Though it offers an enticing opportunity to boost returns, it simultaneously amplifies the accompanying risks.

In this blog, let’s dive deep into leverage in crypto trading.

What is Leverage in Cryptocurrency Trading?

Let’s look at leverage in cryptocurrency trading and margin trading first. There are two fundamental types of trades:

• Long trades: Traders purchase assets at a set price and later sell them at a higher price, enabling them to generate profits, even without the involvement of an exchange or broker, by simply buying and reselling crypto.
• Short trades: A trader borrows an asset from a broker, sells it, and subsequently buys tokens back after the price drops, returning them to the broker. When trading crypto without leverage, all trades are initiated at the current market price using funds available in the trader’s account. Nonetheless, short trades inherently involve margin trading, even without leverage, as traders borrow assets from brokers.

In crypto trading, leverage empowers traders with increased purchasing capacity via borrowed capital. Leveraging allows traders to augment the size of their positions, thereby heightening the potential for greater profits.

Nevertheless, since only the free balance of the account is used as collateral, it’s crucial to remember that the market might move unfavorably against your position. The higher the leverage ratios, the larger the profit potential with a one-pip price movement, and the nearer the liquidation level, which can result in significant losses.

Types of Leverage Trading in Crypto

#1 Margin Trading

Margin trading is a trading strategy that involves investing assets borrowed from a third party. It allows traders to access larger sums of capital and leverage their positions.

Margin trading in crypto boosts trading results so traders can receive more profits on successful trades. It is prevalent in low-volatility markets, especially the international Forex market since price movements are easily predicted.

Margin trading has higher risks in cryptos. Owing to the high levels of volatility in these markets, crypto margin traders should be cautious, and crypto beginners—watch before you jump in.

Interpreting charts, recognizing trends, and determining entry and exit points only help anticipate risks and trade better and more effectively, not eliminate them. 

Before you leverage crypto trades, acquire an intense understanding of technical analysis and spot trading experience.

#2 Futures Trading

Futures are a kind of derivative trading instrument. These are regulated trading contracts between two parties that involve an agreement to buy or sell an underlying asset at a defined price on a specific date.

With futures, investors can protect themselves from unpredictable market conditions and guarantee that they can buy or sell a specific crypto at a given price in the future. However, if the price changes against a trader’s wishes, they may buy Cryptos for more than the market price or sell them at a loss.

#3 Options Trading

A contract known as a Crypto Option provides you with the option, but not the accountability, to purchase or sell a particular asset at a specific price.

• Call option contract: The right to purchase
• Put option contract: The right to sell

Investors purchase and sell these contracts on an open market through options trading. This kind of trading essentially lowers risk because there is no onus to buy or sell.

Not all options trades, however, include risk. With options trading methods, you may either pay someone to assume the risk on your behalf or get rewarded. They also let you protect against potential losses while speculating on the price of an asset in the future.

Pros and Cons of Leverage Trading

Pros of Leverage Trading

• Enhanced Profit Potential

Leverage trading inherently magnifies the scale of your trades. Consequently, even minor market fluctuations can translate into substantial returns on your initial investment.

By managing a larger position with a relatively smaller capital outlay, traders can realize significantly higher profits than conventional trading methods.

• Ability to Engage in Short Positions and Profit from Market Downturns

A primary benefit of leverage trading lies in its capacity to generate profits from declining markets, not solely from upward movements. This is accomplished by initiating short positions, wherein traders speculate against the asset’s price. If predictions are accurate and the market price declines, traders can accrue profits.

• Exploration of New Investment Opportunities

Leverage trading facilitates the swift exploration of novel investment avenues. By committing only a fraction of the total trade value, traders can diversify their portfolios, delve into various market sectors, and substantially amplify their purchasing capability.

Cons of Leverage Trading

• Risk of Total Capital Loss

The downside of the potential for increased profits is the elevated risk of substantial losses. Just as gains are amplified, so too are losses. There exists a tangible risk that a trader may deplete their entire initial investment or margin, particularly in volatile market conditions.

• The Incurrence of Additional Fees for Credit Fund Usage

Leverage in trading comes with a cost. Brokers and exchanges commonly impose supplementary fees or interest on borrowed funds. These expenses can erode profits or exacerbate losses, particularly if trades remain open for prolonged durations.

• Dangerous for Beginners

Leveraged trading is a sophisticated instrument that demands a solid understanding of market dynamics. It offers seasoned traders opportunities to diversify investments across various exchanges. However, the learning curve is steep for beginners.

They must grasp the complexities of the crypto market, comprehend the nuances of leverage, and employ strategies to mitigate significant losses.

Conclusion

Leverage trading allows crypto traders to initiate larger positions through borrowed capital, offering avenues for heightened profit potential alongside downside risks. The primary leverage mechanisms accessible in crypto include margin trading, futures, and options contracts.

Effective risk management is crucial, considering leverage’s capability to magnify both gains and losses, especially within the highly volatile crypto markets. With cautious handling, leverage can serve as a potent tool.