How does leverage work? More volume - more profit

Leverage is a tool in the derivatives markets that allows users to borrow capital from the exchange. It allows traders to control large positions using limited capital.

Now in simple words: if you have $100 at your disposal, you can use leverage and increase your position with it. On some exchanges and assets, leverage can be as high as 500x. This means that if you want to open a position with your $100 and add 500x leverage, your position will increase 500 times, i.e. your margin will be 50000$ instead of 100$.

Leverage is denoted by the ratio: 1x5 (5x), 1:20 (20x), 1:100 (100x) - it shows how many times the volume of your position will increase when you open it.

Leveraged trading is an opportunity for a trader to control positions in excess of their equity.

In order to borrow funds from the exchange, a trader needs to replenish his wallet on his trading account. Your initial capital will serve as collateral or security. The amount of collateral required is determined by the level of leverage and the total value of the position you are going to open - this is, in fact, your margin.

Here is an example: if you want to open a $1000 BTC position with a leverage of 10x, you must have $100 in your account to collateralize your position. The margin that will serve as collateral is 1/10 of the $1000 you want to open a trade for. If you decide to use 20x leverage, you need even less collateral (1/20 of 1000$ = 50$). However, it is important to realize that the lower your margin and the higher the leverage, the closer the position liquidation level is (this mainly applies to positions using isolated margin).

If you do not want your position to be liquidated when the market is not in your direction, you should maintain a margin threshold for transactions, i.e. replenish your trading account balance to avoid position liquidation. We do not recommend doing so, as ignoring the risk management of a position can lead to even greater losses.

When opening trades in the derivatives markets, in addition to choosing leverage, the trader can also choose the type of margin - cross or isolated.

Cross-Margin: This approach to margin allows a trader to use their total capital to cover margin on all positions. Thus, if you set up cross-margin and open a $100 trade, even with 100x leverage, the liquidation level of your position can be much further away as it is covered by the sum of your entire balance. Also, the collateral available for one position can be used to cover the margin of other positions. This can be beneficial if one position has a losing trend, but another position makes a profit and the overall result remains positive.

Isolated Margin: In contrast, isolated margin provides the trader with separate collateral for each position. This means that losses in one position cannot be covered by profits from other positions or even collateralized by the overall wallet balance. This approach brings the position liquidation level closer. At the same time, of course, you can always "top up" the margin on a particular trade. The use of isolated margin is considered a more conservative and yet less risky way of trading.

How to open a position with leverage

In order to open a leveraged position, you need to fund your futures account, then move to the derivatives markets (e.g. trading USDT collateralized futures contracts like on the WhiteBit exchange).

Terminal for trading futures contracts on the WhiteBit Exchange

After that you select the asset you want to open a trade on (upper left corner).

Selecting an asset for trading futures contracts on the WhiteBit Exchange

In the corner on the right you will see a panel where you can select the leverage for the position, and a little lower down you can select the size of the position.

Choosing leverage for trading futures contracts on the WhiteBit Exchange

Selecting a position size for trading futures contracts on the WhiteBit Exchange

After implementing the previous steps, you can buy or sell the selected contracts depending on whether you want to open long or short.

What is Margin Call and Liquidation

Margin call and liquidation are the exchange's defense mechanisms to prevent traders from incurring debts and creditors from incurring losses.

Margin Call is a situation when a trader does not have enough collateral (margin) in the account to cover losses on open positions. The exchange sends a notice (margin call), requiring the trader to deposit additional funds to the account or close part / all open positions.

Liquidation: is the process by which an exchange automatically and forcibly closes a trader's open positions due to a lack of collateral to cover losses. Liquidation occurs as a result of reaching the liquidation level, which is known to the trader.

To avoid such notifications, you should control your risks and use stop losses.

Is it worth trading with leverage? Pros and cons

Leverage trading has both positive and negative sides. If you adhere to risk management, such trading will be more positive for you.

The pros of leveraged trading:

1. Increase potential profits: one of the main benefits of leverage is the ability to control positions that exceed your capital, which can increase potential profits.
2. Increase capital turnover: leveraged trading can increase capital turnover by allowing the trader to participate in more trades.
3. Ability to use small amounts of capital: for many traders, leveraged trading provides an opportunity to participate in the market, even with a relatively small initial capital.

The cons of leveraged trading:

1. Increased risk: One of the main disadvantages of leverage is increased risk. Losses can also be increased as well as potential profits. There is a risk of losing all capital if risk management is not followed.
2. Margin Call and Liquidation: If a position moves in an unfavorable direction, the exchange may require additional collateral (margin call) or automatically close the position (liquidation) when a certain level is reached. In this case, the trader will lose the entire margin amount.

To trade with leverage, it is very important to clearly develop a risk management strategy and thoroughly study all aspects of this financial instrument.

What are the risks of leveraged trading?

• The higher the leverage, the lower the margin requirements on the balance sheet, but closer liquidation.
• The lower the leverage - the higher the margin requirements on the balance sheet, but further out - liquidation.

The main risk associated with leveraged trading is position liquidation.

As we wrote earlier, if you do not have enough collateral (margin) to cover your losses, the exchange may require additional funds or automatically close your positions. In this case, you will lose the entire balance amount.

The market is a living organism managed by people. The price of an asset is formed on the basis of many factors, including completely unexpected ones (breaking news). Because of this, markets can be highly volatile. When a trader uses leverage, even small movements can significantly affect his account.

Why is leverage irrelevant?

You can trade with a leverage of 125x and not be afraid of liquidation. How? The answer is risk tolerance.

Now let's look at an example.

The WhiteBIT exchange has a calculator of future position, in which you can calculate all the risks of a particular transaction.

Now let's calculate our positions using different leverage.

Let's imagine that we have a deposit of $20000 and we want to open a trade with a risk of 1% of this deposit - that is, the maximum we can lose is $200. I open a position on BTC in long from 27700$, stop-loss I plan to set at the level of 27400$. Leverage - 2x.

We open a trade for 0.668 BTC. Margin requirements to our balance are 9251.8$. We can lose $200, as originally planned.

Now let's increase our leverage to 10x.

The margin required from us has decreased to $1850.3. The position size remains the same. We will also lose 200$ as we planned.

Let's increase the leverage to 50x.

What we have: margin requirements to the balance - 370$. PNL is still -200$. The position size has not changed either.

What does this tell us? That if we set the stop at a certain level and observe the risks, it does not matter what leverage we will use, because we will lose the same amount in case of an unfavorable situation in the market.

Leverage: tips for beginners from Cryptology.KEY experts

Leverage is an opportunity and a risk that, if not handled correctly, can cause you to lose your hard earned money. It is important to understand that leverage can play out in your favor without a proper trading system and effective money management. Remember that it is the total size of your position that matters, not the leverage you are trading with.

Beginners often play with leverage, changing it, but this makes no sense, and there is even a risk, because at the moment of opening a trade you can forget about the previously changed leverage and open a trade on the wrong volume, which can reduce or increase your profit or loss.

For more effective risk control and competent capital management, we recommend using position calculators in Trading View (tools called "long position" and "short position"), which will help to limit the risk of each trade individually.

If you want to learn more about cryptocurrencies and get skills, experience and tools that you can immediately apply in the cryptocurrency market - sign up for trading courses at the CRYPTOLOGY trading school.