The Ultimate Guide for Trading BTC with Leverage
Among the modern BTC trading industry, there are two primary methods for how assets are exchanged, or traded, among others in the same market. Leverage and Margin are the most popular, and though having much to do with each other, they are very different methods of trading. What is Leverage Trading? What is Margin Trading? How does Margin Trading have anything to do with Leverage Trading? How is Leverage Trading used, and in what markets does it matter most? Read on to answer these questions, and examine an in-depth analysis of differences between Margin and Leverage trading, in hopes of gaining a higher knowledge about both by the end!
Before diving into examples and comparisons, it’s essential to first define Leverage and Margin trading. So what exactly is Leverage Trading and Margin Trading? Leverage, short for Leverage Trading, is the type of trading assets allowing a client to trade without putting up the full amount. In other words, Leverage is an investment strategy of using borrowed money/assets (usually through the use of various financial instruments or borrowed capital) to increase the potential return of an investment (trade value). On the other side, Margin Trading is a type of trading allowing a trader to open a position using leverage; essentially, Margin Trading is a loan extended by your broker which allows you to leverage the funds and securities in your account to qualify to enter larger trades. It’s critical to know and understand how Leverage is used, and why it’s used, to understand Margin Trading.
Margin Trading is made possible from the existence of the lending market, the market allowing anyone to apply for borrowed money, which is then directly used to enter trades (such as the BTC trading market). Lenders provide traders with loans, enabling them to invest in larger amounts of coins. In a way, both the lenders (person lending money) and the trader (person borrowing money) benefit from this in the way that as trading expectations are to gain from the initial value entered, thus leaving the lender and trader with a higher value than what was borrowed. This allows both the lender AND trader to gain, the lender receiving income based on interest from the loan, and the trader absorbing the interest from the loan through profits made while trading. But this is entirely risky, especially for the trader; in the case of the margin of trade failing to be greater than the price of (1) the initial loan and (2) the added interest, the trader then loses the investment, and begins to accrue debt.
As mentioned above, the cost of the margin position includes paying the interest for the borrowed coins, in addition to fees for opening a position with the trade market (exchange). As the chance to earn more profit increases, so does the risk to lose more. The maximum a trader can lose is the amount he/she invested in order to open the position. This level is usually referred to as the liquidation value. It’s where the exchange would automatically close the trader’s position to prevent losing any loaned money, leaving the losses to the trader’s own money.
In the case of Bitcoin, trading on a margin allows the trader to open increased positions with no need to provide the Bitcoin required. This allows the trader to hold less coins on the exchange account. For example, if a trader’s wallet consists of five (5) BTC and he/she wants to prevent loss in BTC decline, 10X leveraged short position could be open, and would be about equivalent to around 40% of the trader’s wallet. As a requirement to open the position with a lender, the amount must be equal to or exceed only one tenth of the value (10 times leverage). In other words, the trader would only need to hold 0.2 BTC to proceed with the transaction, and the rest of the “invested” coins are safely stored in cold wallets.
Using the information outlined above to create an image of margin trading, understanding the concept of leverage trading is equally important, as it plays a key role in the modern BTC market, especially in margin trading. Going hand-in-hand with margin trading is leverage trading. Essentially, you use margin to create leverage. Leverage, by definition, is the increased buying power that is available to margin account holders. In other words, leverage allows you to pay less than full price for a specific trade, giving you the ability to enter larger trade positions than what would be possible with your account funds alone.
Another key concept about leverage is that it’s expressed as a ratio. A 2:1 leverage means that you (the trader) would be able to hold a position in the market exactly twice the value of your trading value of your trading account (before loans). Suppose you have $25,000 USD in your trading account with 2:1 leverage after adjusting for loans made through margin trade. Using the ratio 2:1 leverage, you would be then able to purchase exactly twice your account value worth of stock, at $50,000 USD.
Keep in mind that not all are eligible for margin trading, and the availability of leverage trading for those who ARE eligible can vary by market. Usually, stock traders utilize a 2:1 leverage, whereas forex traders (specifically BTC markets) use up to 50:1 leverage. While more may seem “better” in the eyes of the trader, it’s most important to identify the risks that come with leverage. By nature, leverage magnifies both gains and losses.
EXAMPLE USING BOTH MARGIN & LEVERAGE TRADE
Suppose STOCK X is trading at $100 per share, and you believe that it will rise in value in the near future. Using 2:1 leverage, you use the $10k in your trading account and $10k of margin from your lender to buy 200 shares of STOCK X. Without the margin, you would have been able to purchase only 100 shares. This is the application of margin trading, in this case being used to your advantage.
Continuing the scenario, after the company successfully releases a new product and begins raking in very strong earnings, STOCK X jumps 25%, climbing to $125/share. Your investment then becomes worth $25,000, and you decide to close out the position. You then pay back your lender the initial $10,000 you borrowed, leaving you with $15,000 and $5,000 in profits. Thanks to the application of leverage, you were then able to realize a 50% return on your money, even though STOCK X advanced by only 25%.
Now, assume that the trade scenario goes the opposite direction. Rather than climbing 25%, a situation of high severity involving the company’s management causes the stock to yank downward by 25%. Now having each share worth $75, your total investment is now worth $15,000. By suspecting that the price will continue to decline, you then decide to close out of your losing position. You pay your lender the initial $10,000 you borrowed, leaving you with $5,000 remaining, and a 50% total loss, not considering commissions and interest. Had you not traded on margin, you would have only lost 25%, as opposed to a 50% loss with margin and leverage.
Trading on both margin and leverage have inherent, and in some cases severe, risks, and may not be appropriate for everyone involved in trading, regardless of the predictability or stability of the market. While trading on margin and using leverage can increase your returns and allow your account to grow much quicker, much caution should be used. It’s also more than possible to lose more than you originally invested when using a margin, but these risks can be minimized by using stop loss orders and limiting your use of leverage (ratio). And for beginners with minimal experience in-market especially, thoroughly test any trading plan before putting it in a live market and risking real money.
POPULAR TRADING EXCHANGES, EXPLAINED
Bitmex – This young exchange has quickly gained a largely positive reputation, and many traders use the exchange often. It’s known to be the leading margin trade exchange, as it offers up to 100X leverage margin trading, available in both long and short terms. The site has an easy interface, and carries excellent support.
Bitfinex – Bitfinex is among the top exchanges, known to boast having the largest BTC (USD) trading volume in the industry. Margin trading is offered up to 3.3X, but the user interface is simple, and it’s incredibly easy to carry out transactions using the site.
AVAtrade – This world-known CFD (contract for difference) exchange allows traders with features for trading major crypto currencies’ CFD, most popularly Bitcoin. The site is lesser known for having outstanding margin rates, but still offers an excellently regulated market for beginners.
Poloniex – Perhaps known as the largest crypto exchange in many respects, the site currently does not support BTC (USD) trading. Leveraging is only available to users at 2.5X, and, combined with high interest fees, the site isn’t the best for margin trading when compared to its competitors.