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Trading with leverage: risks and rewards

Trading with leverage is a high risk/high reward method of trading that allows investors the opportunity to make higher returns than what traditional trading can offer.

This is because trading with leverage involves borrowing capital from an exchange in order to control larger positions than a user holds in their account. Traders with a smaller portfolio can use leverage in order to increase the potential profit of their trades. It should be noted at the outset that this is a high risk method of trading, which can result quite quickly in losing one’s trading funds. Proceed with caution, learn the risks, and keep an awareness of your own experience and ability as a trader.

There are three important figures to consider when leverage trading: margin, leverage, and notional size. Margin is the initial amount a trader holds in their trading account that will be put up for trading, while leverage is the multiplier by which the margin will increase. Often, this multiplier can be set by the user. When multiplied together, these two numbers – the starting amount of capital and the multiplier – equal the amount of funds a leverage trader will be able to trade with; this is called the notional position size, or simply, notional size.  

Margin x Leverage = Notional size 

Let’s take an example of using leverage. I deposit $200 worth of funds into my account on an exchange so I can leverage trade with a 10x ratio. My margin is therefore $200, while my leverage is 10x. My notional position size is therefore $2000, meaning that I have $2000 worth of funds I can trade with. Being able to trade with $2000 obviously brings more potential gain than being able to trade with my original $200. 

With these funds, there are different types of leverage one can trade with, but the most popular ways to leverage trade are by placing either long or short margin trades.

Long Margin Trade:

  • If I think that an asset will rise in price, I can open a “long” margin trade (or simply, a “long”), meaning that I am betting that the asset will hit a higher price than at what it currently trades . If the market price meets my target price, then I will profit from the price increasing.

Short Margin Trade:

  • If I think that an asset will drop in price, I can open a “short” margin trade (or simply, a “short”), meaning that I am betting that the asset will hit a lower price than at what it currently trades. If the market price meets my target price, then I profit from the price decreasing. 

Using leverage can be a very profitable trading method if the trader knows what they are doing. However, leverage trading can be a double-edged sword, particularly if the trade does not go according to plan (e.g. the asset rises in price when you opened a “short”, or vice versa). Trading with leverage is one of the riskiest trades you can make in crypto, and this is why the reward potential for profits is also high. Please be aware of the risks that come with leverage before you start placing leverage trades, as one can lose a substantial amount of money very quickly. In sum, risk management is key when using leverage.

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