If you are interested in trading cryptocurrency, but do not have a large amount of capital to start with, leverage and margin trading might be for you. It lets you borrow money from a broker to increase your buying power, offering the potential for greater profits.
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Before you get started though, you need to put in the research. If you want to learn more about how leverage and margin trading works, how you could profit, as well as the risks involved, read on for a step-by-step guide.
What is leverage & margin trading?
How margin trading works
While many traders have heard of margin and leverage trading, few are familiar with its meaning. Simply put, margin trading involves using capital borrowed from a broker to invest in something, such as cryptocurrency. It has become increasingly popular in recent years because unlike regular trading, margin trading allows you to gain access to larger sums of capital and leverage your position. In other words, margin trading gives you the opportunity to make larger profits when you make successful trades. In the same vein, however, the potential for loss is also greater.
How does leverage trading work?
With a margin trading account, you put in a percentage of the total order value. This is where leverage trading comes in. Traders use margin to create leverage. Leverage gives you increased buying power by allowing you to open larger positions than you would ordinarily be able to if you could only use the money in your account. You will usually see leverage described as a ratio, such as 1:10, 1:20 or 1:30.
Because of crypto’s volatility, allowing people to potentially profit from large and fast swings, cryptocurrency CFDs have become a popular strategy on trade markets such as eToro’s, since margin trading can be used to open both long and short positions. With cryptocurrency margin trading, you can buy crypto if you think the value is going to go up (and profit from the price rising) or sell it if you think it is on the way down (and profit from the price falling).
How does leverage trading cryptocurrency work?
Leverage trading Bitcoin or crypto essentially lets you amplify your potential profits (and conversely, your losses) by giving you control of between 5 and even up to 100 times the amount you needed to open.
So, for example, if you wanted to invest $10,000 in a stock at a leverage ratio of 1:10 — making the margin 10% — you would only need to invest $1,000. With unleveraged crypto trading, you would need to invest $10,000; that’s a considerable amount more. However, if your stocks go up, your profit margin is exactly the same. In other words, with leverage trading Bitcoin, much less capital is required up front to make the exact same profit. Of course, it is worth bearing in mind that the reverse is also true if your stocks were to go down.
How to manage risk when leverage and margin trading
Margin trading can amplify your gains, but that means it can also amplify your losses. This is the biggest risk of margin trading. Here are some tips on how to manage that risk.
- Stop Loss: A Stop Loss is a risk management tool designed to close a trade at a specific amount in the event that the market moves in a direction you do not want it to go. It is a really helpful way to ensure that you know exactly how much money you risk losing. You can learn more about it here.
- Don’t Risk More Than You Can Lose. No matter the success rate of your strategy, margin trading Bitcoin can go against you extremely quickly, so you should never invest more than you can afford to lose. Generally speaking, risking more than 5% of your account is asking for trouble. You want to invest an amount that you could pay off should your investment go south.
- Take Profit: A little like the opposite of a Stop Loss, you can set a Take Profit order to close your position when the profits hit a specific amount. Because crypto is so volatile, it can be smart to get out before the stock turns in another direction.
- Negative balance protection: If for some unusual reason, market conditions cause your equity to go negative, some trading platforms will absorb the loss and reset your equity to zero. This is a protective measure that eToro provides.
Pros & Cons of Leverage Trading Cryptocurrency
Like all trading strategies, margin trading assets such as cryptocurrencies comes with both advantages and disadvantages. The advantages and disadvantages tend to mirror each other to a large extent. For example, your potential profits are greater, but this also comes with an increase in the amount of money you can lose if a trade goes against you. Similarly, you can easily and quickly diversify your portfolio at the cost of a much higher risk than other trading methods. See the table below for additional examples:
|Greater Profits||Greater Losses|
|Trade with limited funds||Can lose capital quickly in volatile markets|
|Teaches discipline and risk management||Harder for newbie traders|
Cryptocurrency Margin Trading Strategies
There are plenty of possible strategies to apply to margin & leverage trading cryptocurrency. Here are some for your consideration:
- Gradually Increase Trade Size — Especially beneficial for newbie margin traders: starting with small positions and increasing your leverage only as you get more experience, can be an effective strategy to limit risk when starting out.
- Practice Trading with Demo Trading — By using a so-called demo (otherwise known as paper trading) account such as this one on eToro, you can learn the ins and outs of leveraged trading without risking any real money.
- Set clearly defined goals and minimize risk — Having a sensible risk management strategy and clearly defined profit goals can greatly assist you in avoiding emotional decision making that may result in a loss.
- Divide your Positions — Another method for minimizing risk is to divide your positions into separate portions, for example, you could set a series of taking profit orders to capture your profits incrementally, rather than all at once when your single take profit is reached.
- Limit the time period of your trades — Consider limiting the time that you hold any one position in order to limit the risk of unforeseen price drops and long-term market corrections.
The final word
Margin trading crypto and leverage trading can be a little daunting at first, but once you have learned a little more about it, and are willing to take a hands-on approach with your trading, it can be a profitable trading strategy. Bottom line: don’t get carried away. Margin trading might not require you to have the same capital as traditional forms of investment, but that does not mean you ought to risk more than you can afford to lose. By setting up a Stop Loss and investing smaller amounts of real leverage, you reduce your risk and give yourself more room to breathe. As time goes on, the more skills you gain, the more you will be able to navigate highly leveraged markets.