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Leverage is one of the important concepts in financial markets and a tool to gain more profit in transactions. In fact, leverage refers to the use of borrowed money to trade. Leverage, in simple terms, allows you to borrow money from the exchange or broker and trade with greater power in the market through larger positions. This trading tool is used in Forex, stock and digital currency markets and will be available to traders through margin or futures transactions.
With the help of Leverage, capital can be increased up to 200 times in trade; Of course, if you do not have the necessary skills, you may suffer a lot of loss.
Leverage trading means borrowing some digital currency to strengthen buying and selling power with low initial capital. Therefore, if you have a small amount of capital, you can use the leverage to register larger orders. In the continuation of this article from the Crypto School website, we will discuss more about the concept of leverage in digital currency transactions and its advantages and disadvantages.
What is leverage?
By using credit or leverage, the amount deposited in the transaction can be increased. Leverage increases the profit and loss from trading, and therefore it is very important to know the rules of its use. Increasing the power of the position, leveraged trading or leverage simply means using borrowed capital to trade a larger volume of financial assets such as digital currency. Using this leverage multiplies your buying and selling power, so you can trade larger positions with the currencies in your wallet.
Leverage is used in futures and margin transactions and provides investors with the opportunity to achieve faster profits. For example, if you invest 10 dollars of your capital in leveraged transactions, your desired exchange will give you an amount as a loan for the transaction. For example, for 10 dollars with leverage of 10, your capital will be 100 dollars and thus your profit margin will also increase.
What is the important point of leverage in digital currency?
Leverage is used in digital currency in margin and futures markets. Digital currency exchanges basically allow traders to use 1:100 leverage in their transactions. Depending on the rules of each digital currency exchange, you can borrow 100 or sometimes 200 times your account balance and trade digital currency with leverage. Therefore, for leverage trading, you can deposit some of the initial digital currency into your account and by leveraging it, borrow money based on it and pay for larger trade positions.
Of course, the important and noteworthy point is that using leverage in the digital currency market can increase the probability of your profitability, but it can also cause the loss of all your capital. Therefore, one should always be cautious in using leverage and consider capital management and financial risk so as not to call margin in the financial markets.
Leverage is actually a trap spread for you by the broker or exchange to increase your risk and provide the basis for your margin call. In my opinion, a person who uses Leverage is not an investor but a gambler.
From my point of view; Leverage is a lever that the broker, broker or exchange puts under your capital and artificially raises your capital. for example; Imagine that you invest 1000 dollars in a brokerage so that you can buy and sell stocks and… The broker will give you 1:100 leverage, which you can accept or not. When you accept this leverage, you can trade up to 100,000 dollars with your 1000 dollars using this leverage.
But the amount of your loss in each transaction should not be more than your initial capital or margin. As soon as your loss in the position is higher than the margin road (for example, $999), the broker will not allow you to lose more, and you are called a margin call. It means that you either have to increase your margin or your position will be closed. One of the worst things in the capital market is a margin call.
The most important financial risk management methods in the cryptocurrency market is to never use leverage in the cryptocurrency market. It is the same in other financial markets. But since the volatility of the crypto market is much higher than other markets, this point must be taken into account in the market.
How does leverage work?
Credit performance or leverage is based on the amount you invest in the exchange you are considering. Leverage is used in futures and margin trading and its purpose is to access more profit in less time. When you use leverage, the exchange lends you an amount as leverage. You enter the trading market according to the amount of your capital; But in the calculation of leverage, the profit you earn is based on the current amount borrowed from the exchange.
In other words, using margin transactions is like killing two birds with one stone. You enter a small amount into the transaction and you will get more profit by borrowing from the exchange. Exchanges, in exchange for the money they lend you, deduct a fee from your profit after completing each transaction.
For example, imagine that you plan to buy 1000 Cardano currencies at a price of 0.5 dollars. You need 500 dollars capital to do this transaction in spot or normal mode. While buying this number of Cardanos in futures transactions with leverage 10, you will only need $50.
Comparison of leveraged and non-leveraged transactions
In unleveraged trading, you can trade only in the upward trend of the market and with your real capital. Therefore, the amount of your profit and loss is relative to your own capital and you bear less risk. But leveraged transactions are different and you can make a good transaction and profit even with a small capital. But leveraged trading has a very high risk and allows you to make profits in both rising and falling markets. Proper use of leverage in digital currency is a smart decision a trader can make. But due to the high level of risk, it will bring the possibility of losing your entire capital.
In addition, Mr. Farhad Moghadam Salimi warns you not to use leverage in any way in the cryptocurrency market. They consider leverage as a trap that brokers spread for people and have warned you of the risk of margin inflation.
In which markets can leveraged transactions be used?
Leveraged trading is one of the most common trading methods used in different markets. Knowing these markets will help people to achieve profitability using leverage. In the following, we will mention the markets that support leveraged transactions:
Cryptocurrency market
One of the platforms supporting leveraged transactions is the financial market related to digital currency. Leverage is highly popular in digital currency and allows you to make profitable trades. In this market, you can trade all kinds of digital currencies with low or high leverage.
Forex market
In the forex market, you can use leveraged transactions and trade different stocks. Forex brokers usually offer traders leverage from 1:100 to 1.2000. Traders can do multi-lot transactions in this market using a small amount such as 400 or 500 dollars.
commodity market
In this market, you can trade more than 35 different commodities such as oil, gold, silver, etc. with various coefficients.
Option trading
These types of transactions have a high risk and are carried out in the Binance exchange. In option trading, traders have the option to trade assets at a specified price at a specified time.
The difference between leverage (leverage) in the forex market and digital currencies
Leverage in the cryptocurrency market increases your profit in the transaction. But in the forex market, this lever is a tool that you can use to increase your capital to the amount that you are able to enter into a transaction. In fact, leverage in forex has no effect on profit and loss. Therefore, it is better to have more leverage in Forex. By choosing a higher leverage in Forex, you will reach the stop-out and margin call level later.
Therefore, unlike digital currency, where choosing a higher leverage resulted in more profit, this effect is not observed in forex.
In the commodity market, the amount of leverage depends on the traded commodity and can vary between 1:1 and 1:100. This is while in the forex market leverage is 1:1000 or even 1:3000 depending on the broker. The reason for this is the low fluctuation of exchange rates against each other, which provides the possibility of astronomical leverage. In the crypto market, due to extreme fluctuations, the maximum applicable leverage is usually equal to 1:125, which also depends on the chosen currency and broker.
Application of leverage and leveraged trading
The use of credit or leverage in transactions can have reasons such as the following:
Increase purchasing power
As mentioned, traders use leverage to increase capital size and potential profitability of digital currency transactions. But leverage trading also increases the risk of heavy losses.
Increase liquidity
Another reason for using credit or trading leverage is to increase capital liquidity. For example, by having a 2x leveraged position in one exchange, you can have a 4x position of the same amount in another exchange with less capital.
Application in DiFi
The increased liquidity from Leverage allows you to use the rest of your capital in other areas such as staking, investing in NFTs, providing liquidity for decentralized exchanges, and other cases.
Various transactions
In addition to the above, digital currency leverage can also be used in transactions such as futures contracts and margin.
The difference between leverage and margin
As we said, leverage or trading leverage means increasing the power of the position by using borrowed capital. Therefore, to start leverage trading, you need to deposit some initial capital to borrow from the exchange. This initial capital is known as collateral. The collateral depends on the amount of selected leverage and the total value of the position, which is introduced as Initial Margin.
For example, imagine you want to buy $1,000 worth of Ethereum with Leverage 10. To open this position, you need to provide 10% of the total value, i.e. $100 as collateral, in order to borrow the remaining $900 and open a $1000 Ether position. Now, if 20x leverage is used, the amount of collateral for borrowing becomes 5% of the total value, equivalent to $50.
Although the increase in leverage will reduce the amount of collateral required, on the other hand, it will increase the risk and the risk of liquidating the account. Liquidation means that if, as a result of strong market fluctuations, the price movement goes against your prediction, there will be a possibility of losing the entire secured collateral. In fact, Leverage specifies the amount of position tolerance (tolerable fluctuation amount in the transaction before liquidation).
In addition to the initial deposit margin, you must have a maintenance margin threshold to keep the account open. In different exchanges, the formula for calculating the maintenance margin and its threshold are different.
In order to avoid liquidation in case of market fluctuations and the value of the balance reaches below the maintenance threshold, one should either reduce the amount of leverage used or deposit some money to increase the value of the account.
How to calculate leverage and leverage in digital currency
Imagine that based on your analysis, you come to the conclusion that the price of Bitcoin will have a high growth. In this case, you decide to invest in Bitcoin and you only have $10,000 in your account. While the price of Bitcoin is 30,000 dollars. Therefore, you decide to buy a leveraged token with 3:1 leverage instead of buying Bitcoin.
Read more: Bitcoin price depends on what factors?!
In fact, in this case, you will triple your initial asset, if your prediction is correct and the price of Bitcoin increases, the profit obtained from this transaction will also triple. Of course, you should always keep in mind that this equation also applies to price reduction.
Another way to calculate the profit and loss of the transaction and calculate the leverage is to use digital currency leverage calculator. Almost all exchanges have placed this calculator for their users. For example, by using the Binance futures calculator, you can easily calculate the profit and loss, the percentage of return, as well as the amount of the initial margin for the transaction. Calculators use the following formula for their calculations in short and long transactions:
(exit price – entry price) = short profit and loss
(entry price – exit price) = Long’s profit and loss
Advantages and disadvantages of using lorij
As explained so far, the increase in purchasing power and potential profitability was considered one of the most important advantages of using leverage in digital currency. At the same time, one of its disadvantages was the increased risk of liquidation of the account in the event of the movement of the cryptocurrency against the predicted direction in the severe fluctuation of the market. Below are some other advantages and disadvantages of leveraged trading:
Advantages:
- Can be used in companies that want to meet short-term financial needs to acquire other companies or their shares.
- Creating more opportunities for investors to access more trading opportunities
- Greater freedom of action in digital currency investment and portfolio management
- Increase in profit
- The possibility of trading in both market trends
Read more: Fundamental analysis or fundamental analysis
Disadvantages:
- Greater complexity and the need for additional capital and time based on portfolio requirements
- It has various fees such as premium rate and margin of future contracts regardless of failure or failure in the transaction
- Possible destruction of the entire capital
- No use for long-term investors and holders
- Failure to maintain the principal of capital
How to activate Leverage?
If you have come across the question of how to activate Leverage, you must answer to enter the exchange account of your choice. Enter the Margin Trading section for margin trading and the Futures section for future trading. In the following, for example, we will teach how to activate Leverage in the Binance exchange:
Using Leverage in Binance Exchange
Binance exchange is one of the most famous and well-known digital currency exchange platforms that supports leveraged transactions. To use leverage, first select the [20x] icon in your future transactions. Note that if you don’t set the leverage before placing an order, the system’s default leverage of 20 times will be automatically set for you.
In the next step, the Adjust Leverage page will be displayed for you.
You can adjust the leverage by moving the mouse pointer or selecting the [+] or [-] icons. After setting the lever, select the confirm option.
After this step, the new lever will be visible to you. Before placing an order, you must make sure that the lever you have chosen is correct. In the picture below, lever 50 is selected.
Which traders are leveraged trading suitable for?
These types of transactions are high-risk and profitable transactions that are not suitable for all traders. By doing these transactions, you can achieve high profits in a short period of time with a small investment. Mr. Farhad Moghadam Salimi has introduced this kind of transactions as a trap to get caught and increase your margin. Considering the volatile cryptocurrency market and the high risk of leverage, they prohibit people from doing it as much as possible.
But if you intend to make such transactions, you must meet the following conditions:
Full knowledge of leveraged trading
The first condition for participating in leveraged transactions is to have sufficient information about how to carry out leveraged transactions, prevent liquidity, and apply profit and loss limits. With this data, you can easily enter leverage trades.
Having the ability to analyze market trends
One of the requirements of trading is the ability to accurately analyze the market. In spot trading, this is not a big risk because you can avoid big losses by averaging out. But in leveraged transactions, you cannot enter into a transaction without a detailed analysis; Because instead of making a profit, liquidation and loss of capital will happen to you.
Getting to know the principles of capital management
Capital management is one of the important rules and principles that traders must master. Due to the high risk of leveraged transactions, traders must be familiar with the principles of capital management and have the ability to manage their transactions. Pay attention that most of your capital should go to spot transactions and only 20% of it should go to leverage transactions.
Being a risk taker
Leverage transactions are high risk. Because the digital currency market has strong fluctuations and the price of an asset can grow or fall under the influence of many events. Therefore, if you cannot bear profit or loss within a few seconds and cannot manage it, these transactions are not the right option for you.
Many traders believe that the best leverage for $100 is 1:100. This means that for every $1 your broker lends you $100, you can trade up to $10,000 with your $100.
For leverage 1:500, the required margin is about 200 dollars.
Among the common mistakes in leveraged trading, we can mention excessive leverage, failure to limit loss, lack of capital management, emotional trading, lack of technical analysis and fundamental analysis, chasing losses, and excessive trading.