Trading With Leverage: The Risks vs.The Benefits
Amongst the many types of trading techniques the average trader can make, one of the most popular is trading with leverage. Leveraged trading is also known as multiplying, margin trading, margin finance, or trading on margin. This allows a trader to use a small amount of capital to expose himself to a much higher potential profit. If the right knowledge and experience are not possessed, it can be a risky strategy to use. However, if done right, it can enable an investor to maximize his or her profits beyond the imagination.
How does trading with leverage work?
Here’s an example. You're sure that the price of a stock will go up. However, you want more capital to expose yourself to more profits. In such a case, the investor borrows capital from a broker. In this sense, the amount invested is multiplied as the broker loans it to the investor at a fixed ratio. For example, investors can expect 5x leverage, meaning the position they hold would be five times higher. This number can go even higher. However, depending on what you are leveraging, there is a maximum leverage limitation. Each instrument would be guided by regulations as to how much it can be leveraged.
It is also important to note that investors can buy both long and short positions when leverage trading.
PRO TIP: Learn about the differences between long and short positions HERE.
Nonetheless, investors need to bear in mind that as much as they are increasing their potential for additional profit, it is also increasing their potential losses. Trading with leverage can be used in many circumstances, such as when trading with stocks, currencies, cryptocurrencies, ETFs, commodities, and indices.
When mentioning leverage, one must also understand what margin means. Margin is the amount needed in order to execute a leveraged trade. For example, if one wants to invest $10,000 in the Tesla stock at a ratio of 1:10, he or she would need to invest $1,000. If the price of the Tesla stock would be $500 at that time, this means he or she would have obtained 20 shares.
The pros of leverage trading
There are numerous positives when trading with leverage:
- Exposure to magnified profits: With only a fraction of the value invested, you can receive much greater profits when compared to the conventional trade.
- Expanding investments: This is as it frees up capital that could have been invested in other things. This ability to increase the capital available for other investments is also known as gearing.
- Maximize your decisive investment: If you are sure of your investment, you can increase your holdings with less capital than you have.
Trading Bitcoin with leverage
Again, when it comes to cryptocurrencies, you can apply leverage trading. This allows you to control a more sizeable position in, for example, Bitcoin. Nevertheless, one must bear in mind that this is more prone to volatility due to the nature of cryptocurrency. This is especially true when compared to Forex trading (FX trading). This is as in FX trading, you don’t usually see too many changes above or below 1%. In fact, it is not unusual to get 100x leverage when trading currencies. However, with cryptocurrencies, it is not unusual to see 10% dips or upward movements every now and then. In fact, the ratio when leverage trading cryptocurrencies usually has a lower maximum ratio.
When it comes to cryptocurrencies such as Bitcoin, this trading technique will also affect their profits and losses margin. For example, let us take a scenario of two individuals, Julian and Maria who want to trade Bitcoin with leverage. Let us also say that the price of Bitcoin stands at $10,000. Julian uses leverage with a 1:10 ratio for Bitcoin, while Maria utilizes a 1:5 ratio. Both of them invest $10,000 in the capital. This means that Julian’s transaction value stands at $100,000 or 10 Bitcoin.
Meanwhile, Maria’s transaction value stands at $50,000 or 5 Bitcoin. Should a drop in price of $100 occur with Bitcoin, Julian loses $1,000, while Maria loses $500. Julian, then, has lost 10% of his capital, while Maria has lost 5%. Julian’s trade, therefore, makes him increase his losses but has the potential to earn much higher profits. In the case of profits, then, let us assume that a $100 price increase in Bitcoin occurs. Julian would have made $1,000, while Maria would have made $500. When compared to a trade that is not leveraged (which means that had both of them traded with $10,000), this would have resulted in the original $100 increase in their profits.
Minimizing risk while leverage trading
As noted before, trading with leverage involves a high-risk, potentially high-reward scenario. However, there are certain tools you can use in order to minimize your risks. One of them is adopting Stop Loss. This allows one to close a trade at an indicated loss in the event the trade does not turn out well. Another tool is to set at which point you will take profits, which automatically closes your position when it reaches a certain amount. It is highly recommended that you find a broker which allows flexibility with your trading. With more flexibility, you gain more control over your leveraged trades.
Is leverage trading worth it?
This is a question that the answer varies from individual to individual. If one does not afford to risk the capital that he wants to invest, leveraging may prove to be way too risky. However, if that individual or business can afford to lose what he invests and is sure of the prospects of profiting, it might well prove to be a good trade. Leverage trading, then, proves to be a double-edged sword.
As Naved Abdali, author of Investing: Hopes, Hypes, & Heartbreaks, puts it
“leverage is a two-edged sword. The edge that can cut you, cuts deeper.”
One would always suggest that before thinking about leverage trading, there needs to be certain proficiency with technical analysis of an investment as well as an understanding of market trends. Although you can have the potential to have higher gains, you are also susceptible to worse losses. One should always bear this in mind when trading with leverage. Nonetheless, if one is sure of his or her trade, it offers a great opportunity to increase their profits beyond what they could have with their current capital.
How to margin trade on YouHodler
YouHodler’s Multi HODL tool allows traders from all backgrounds to experiment with margin trading, With our tool, users can “multiply” a cryptocurrency by setting a multiplier level up to x50. It works very much like trading with leverage as described up above. The only difference is it’s user-friendly, and traders have more flexibility when setting their multiplier level in addition to managing risk.
Traders can set Margin Call and Take Profit levels to ensure they exit the market on their own terms. Multi HODL is also unique as it allows traders to long and short the market using the multiplier. Hence, this gives traders more capital to long or short the market depending on which direction they think the market is heading.
So if you are new to leverage or simply want to experiment with a new way to margin trade, head to YouHodler and give our innovative Multi HODL a try today.
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You should take independent investment advice from a professional in connection with, or independently research and verify any information that you find in the article and wish to rely upon.”