What is leverage and how does it work?

Speculating on the price movement of cryptos does not happen randomly. The operation requires a careful reading of the market, a slew of tools and strategies among which is the leverage effect. This is said to be the fastest way to maximize profits.

What is leverage in crypto trading?

Leverage is the use of borrowed funds to trade, in order to earn greater profits. This technique is mainly aimed at increasing the buying power of the trader, which will allow him to trade with more capital than he can have. To access leveraged trading, the trader can borrow 2 to 100 times their account balance. Borrowing capacity depends on the exchange or broker used.

Being able to trade larger amounts increases potential profits, provided of course that the trades are successful. Used by a seasoned trader concerned with risk management, leverage proves to be an excellent strategy for maximizing his gains. But it can also entail significant risks, which can go as far as the liquidation of the account.

Advantages and disadvantages of leverage

Leverage explained by Voice of crypto.

Leverage has, like most crypto trading strategies, advantages and disadvantages.

The main advantages

  • Leverage allows you to quickly make more profits provided you control the market.
  • This strategy helps to increase the liquidity of the funds and increases the investment possibilities.
  • The technique provides greater flexibility by allowing the trader to multiply trades and execute more trades. This, in order to maximize the return on investment.

The inconvenients

  • Using leverage assumes greater exposure to volatility. This means more risk of capital loss if the trader gets the wrong market.
  • The strategy is not recommended for beginners.
  • Traders wanting to use this strategy must have a good appetite for risk and be able to manage it.

How does leverage work?

Leverage is based on a borrowing system. Suppose a trader wants to buy $1,000 worth of bitcoin (BTC), but does not have enough money for this investment. He can use 10x leverage (ratio 1:10) to get those $1,000 worth of BTC with just $100 in funds (to be deposited in the account).

With these 1000 dollars in his account, the trader can take advantage of market fluctuations to make trading profits. Assuming he bets the $1,000 on BTC rising 30%, the trader will make a profit of $300. Of course, if the bitcoin price goes down, the losses are accordingly. The credit available in the trader’s account will then be used to cover this loss.

A risky strategy

Leverage is a quick way to earn more in cryptocurrency trading. But the strategy also carries risks. Traders need to be fully aware of these to be able to master the technique. It is particularly important to understand that the risk of liquidation increases in proportion to the rate of leverage chosen.

The higher the leverage, the lower the margin of error. Even the smallest fluctuation can sometimes lead to massive losses and lead to account liquidation. Fortunately, there are ways to manage these risks well.

Determine the risks for each transaction

To minimize risk, every trader should take the time to determine how much they are willing to risk for each trade. Experts recommend not to exceed 5% of the capital. In trading, the result is never 100% guaranteed, regardless of market control. Too high leverage will expose the portfolio balance to too much risk.

Use Stop Loss

Stop loss is a risk management tool designed to limit the maximum loss from a trade. This solution in this case limits the decline of a trader by closing a position if the market moves in the opposite direction. Stop Loss also prevents panicking and exiting positions prematurely in the face of emotional trading. This article offers a detailed explanation of the tool.

Betting on the Take Profit strategy

This strategy is often used in conjunction with Stop Loss to make crypto trading operations as secure as possible in addition to ensuring profitability. Take Profit orders aim to maximize short-term profits. The strategy consists of establishing a trigger price which will always be higher than the initial price. This ensures that the trader can always sell for profit, regardless of the starting price.

Trade on a separate account

Whatever one may say, regardless of the trader’s level of expertise, the crypto market remains unpredictable with often high volatilities. This is why it is safer to conduct leveraged trading in a separate account. The rest of the capital will be kept in another account.

Practice before starting

In the financial and crypto market, leveraged trading has always been a top strategy. To be able to take full advantage of it, the trader must know when to use it. This will prevent him from running unnecessary risks. Leverage also involves a good knowledge of the market and crypto trading itself.

For beginners, experts recommend practicing before getting started. Time should be taken to increase knowledge about risk management strategies and trading methods. To better understand leverage, nothing beats practice. Beginners can train easily and risk-free on a simulated account.

Leverage magnifies profits as well as the risk of loss. To get the most out of this tool, it is essential to fully understand how it works in order to be able to use it wisely and efficiently when the time is right. It is equally important to understand the risks inherent in this strategy and manage them.

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