LEVERAGE TRADING: ARE YOU A WINNER?

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Leverage trading and margin trading equal either huge gains or big losses, that’s in short what leverage trading for you can do. My name is Rico Richardson, and in this blog I’m going to explain what leverage trading is.

Background

Trading is the buying and selling of goods or services with a compensation being paid by the buyer to the seller. The international trade goes back as far as ancient times with the most famous one in Dutch history being the Dutch East India Company. This was a multinational corporation that was founded by rivaling Dutch trading companies in the early 17th century. They believe it was the biggest company to have ever existed in history. It was established to trade with Mughal India with 50% of the trade being textile and 80% of the trade being silk. It also traded with Indianised Southeast Asian countries when the Dutch government granted it a 21-year monopoly on the Dutch spice trade. Later if would diversify into multiple commercial and industrial activities like international trade, ship building and the trade of spices, coffee and many other products.

Regular trading

However, we’re not here to talk about a business trade. We are here to talk about trading stocks and crypto. There are many stocks and crypto to choose from, but they all have things in common. Stocks can be bought individually or as call or put options. If you buy a call option, you expect the price of the stock to go up. If you buy a put option you expect the price of the stock to go down. The call and put options both have end dates and gives you the right but not the requirement to buy a stock for a specific price at a specific date. A call option has a buyer and a seller, and the call buyer will pay a premium to the call seller. Now stocks can be kept indefinitely but options cannot. Those will run out of time and either be worth some money, or nothing at all. So in short, call and put options have three distinct features. These are a strike price, which is the price at which the buyer can purchase the underlying stock, a premium, which is the price for the option and then finally an expiration date which tells when the option is expired and is settled. So, how does this work in crypto?

A typical trading view. Source: www.pexels.com

Leverage trading

Well in crypto you have several options when it comes to trading. Let’s use Sam as an example which will first purchase a specific asset i.e. BNB or Solana. When the asset Sam has purchased is worth 100 dollars and then moves up to 110 dollars, Sam has gained 10 dollars. But if it drops to 90 dollars Sam has lost 10 dollars. Provided he sells of course. If Sam decided to keep the asset, then all he has is a paper profit or a paper loss. Another way how to trade crypto assets is by using a leverage. Leverage trading allows Sam as a trader to increase his exposure by paying less than the full amount for the asset. If Sam uses a “buy” order, he expects the price to go up, which is called a long position. If he uses a “sell” order, he expects the price to go down which is called a short. You might have heard from the terms Bulls and Bears. Well, if you’re a bull, you expect the price to go up and you have or take long positions (bullish). If you’re a bear, you expect the market to go down and you have or take sell positions (bearish).

Long example

The first thing you need to know is that leverage trading works with percentages. Now let me give you an example:
Sam thinks that the market is going back up again, things are calming down and he read some great news on stores being able to accept crypto payments in their fiat accounts with banks (fiat=USD/EUR etc). So, he expect BTC to go up from 40.000 dollars to 44.000 dollars. Sam decided to take a long position, with 400 dollars in total and with a leverage of 10X (many exchanges offer different options like 2 to 10x but for this example we’ll keep it simple). Now let’s say Sam is right, and the price of BTC moves to a price of 44.000 dollars. This is an increase of 10% in price, but because Sam has used a leverage of 10X, he basically took a position with 4000 dollars (400×10), which means that he has now gained a profit of 4000 dollars. So why isn’t everybody using this? Now let’s say Sam was wrong, and the news he read was an April fools joke. BTC isn’t pumping 10% but instead, it dropped 10% to a price of 36.000 dollars. Because Sam was using leverage, the 10% loss is now 100% loss of funds. Which means that he gets liquidated and loses the entire sum of 400 dollars. Now if Sam would have gotten into a short position rather than a long one, things would have been different.

The market is looking good. Source: www.pexels.com

Short example

Sam knew it was an April fools joke, and expect the market to crash when the news comes out that we’re far from accepting BTC as a legal payment method for all stores. Instead of going long, he decided to go short and use the same leverage. He now fills in a sell order at 40.000 dollars with the same leverage of 10X. If the price drops to 36.000 dollars (which is 10%), his 400 dollars has turned into 4000 dollars as well (10×10=100%). However, if for whatever reason the price went up, the same principle will apply. Sam will get liquidated and lose all of his funds as soon as the price went up by 10%.

Look at him being happy. You know why? Because he sold right before the market went up and took maximum profit. Source: www.pexels.com

Stop loss and Take profit

Now that you’ve got an understanding on long and short positions, I want to let you all know how you can protect yourself from being liquidated. Being forcefully liquidated will convert your crypto assets into cash or cash equivalents to pay off your debt. This happens when you cannot fulfil the margin requirement for your leveraged position. It’s something I had happen in the past, and it’s not fun when that happens because once the funds are lost, you cannot get them back. This is different from buying crypto assets in a regular way. If you purchase Solana at 100 dollars, and it drops 10% to 90, you can still take out 90 dollars and walk away with a 10 dollar loss. So how you can counteract this is by using a stop loss or a take profit. Let’s look at Sam again, and his great insights in the market. He isn’t quite convinced yet, but he wants to take the gamble anyways (because that’s what you’re doing, gambling). So, he puts the 400 dollars in a long position with a 10X leverage. However, he wants to exit the position if things don’t go as planned. So he puts a stop loss order at 38.000 dollars. This means that if the price drops by 5%, the order will be executed and his position will be liquidated. But unlike in the previous example, in this case he’s only losing 50% of his funds (5×10=50%). So instead of losing 400 dollars, he only loses 200 dollars which leaves him with the other 200 dollars that he can either use for a new position or keep in his pocket because there is no way he will use margin trading again… The same principle applies with a take profit order. In this case he is satisfied with a 50% increase in profits. So, he takes a long position and then fills in a take profit order at 42.000 dollars. Once Bitcoin hits this price, his order will go through giving him a profit of 2000 dollars. This is the most easiest way how Sam can protect himself from losing his funds. However, let’s say Sam is a true gambler and things aren’t exciting enough for him just yet. He won’t let himself get “squeezed” out of a position. Whether it’s a long one or a short one, Sam is here to stay and his portfolio and trades are built to last. So, he decided to use collateral funds.

Collateral

Sam has an account with 4000 dollars, but he’s only trading with 400 dollars. He could use all of the 4000 dollars at once but he’s a seasonal trader and knows how to do proper risk managed. Atleast, that’s what he likes to think. Because rather than using the entire amount for one long or short position, Sam decided to use the other 3600 as collateral. On exchanges like Kraken you can margin trade (another word for leverage trading) with collateral. The higher percentage you use, the quicker you will get liquidated when the market goes the wrong way for you. By using his collateral, he won’t get liquidated when the price of Bitcoin drops to 36.000 dollars (40.000 minus 10% remember?). Instead, he can hold his position because he has another 3600 that he has placed as collateral. As soon as a certain threshold is reached, his position will be liquidated, but the difference is that it will take much longer than when he would have just leverage traded with 400 dollars. Most exchanges use a treshold of like 80% before you get a warning to either deposit more collateral, or to exit your position manually. The pro of this, is that Sam won’t get squeezed out of his position so easily. Bulls are fighting Bears every day, trying to liquidate each others position. This is also one of the reasons that when the price of Bitcoin drops very badly, you suddenly see it drop even more. This has to do with the fact that long positions are being liquidated when the market drops. On the other hand, sometimes you see a tremendous boost in price with Bitcoin and this can be the effect of a short squeeze which pushes Bears out of their positions. So during events like this, using collateral will help Sam stay in his position to survive these market circumstances. However, eventually Sam will have to pay up, and that’s the biggest con. If Sam can’t keep up because he doesn’t have any more collateral to use or because he lost faith in the market and decides to cut his losses and close his position, He will have a much bigger loss than when he just would have used a 400 dollar trade on a 10x leverage without collateral.

In summary

There are many ways how you can trade stocks and crypto, and you can use leverage or just buy the said asset. It all depends on your risk appetite and how much you’re willing to lose. Because no matter how many stories you read online, or Youtube videos you watch from people that claim to have become millionaires, the majority of the people are losing money when using leverage trading. Now keep in mind, I’m not a registered financial advisor nor is this post ment as financial advice. It is ment to be educational and entertaining on the topic of leverage trading. A special thanks to Alexios for providing me with the inspiration to make this post. If you want something to be addressed on my Youtube channel or on my website, feel free to contact me. If you like visual presentations about crypto projects, then please visit my Youtube channel

My name is Rico Richardson, thank you for reading this article and if you still have some time left, maybe this is a great starting point as well! I’ll see you next time. Doei!