What is leverage trading: Step-by-step guide 2023

WHAT YOU SHOULD KNOW

Leverage provides traders with additional buying power, flexibility and higher ROI.
Beginners should exercise caution when using leverage in trading.
However, leverage trading can lead to emotional trading and increased risk of losing the entire investment.

Leverage is a fundamental concept in trading that all traders should understand, even if they do not use it immediately. While beginners tend to avoid leverage, it is crucial to grasp its potential benefits and drawbacks.

Leverage enables traders to boost their position sizes by borrowing additional funds, leading to larger potential profits than they would earn with only their own funds. However, leverage trading also entails greater risk, making it important to exercise caution and be aware of the risks involved.

How to Start Trading Using Leverage

Here is a list of steps you can use to start using leverage:

Sign up and create an account. To start trading, you need to choose a broker from the recommended list or compare various options using reviews. After that, you must create an account with the broker by providing your contact details and a form of photo ID. It is usually a straightforward process.
Deposit funds. Some brokers have a minimum deposit amount, and you may also need to keep some additional funds in your account as proof-of-funds in case of any potential losses. Before making a deposit, it is important to decide on a risk management strategy and determine how much you are willing to invest to avoid impulsive decisions and overspending in the future.
Activate leverage. To open a position, first select the asset you want to trade and then determine the margin amount – the initial deposit that you will put down – as well as the desired leverage. For instance, you may decide to invest £10 with a leverage of 10x, which would enable you to purchase £100 worth of the asset.

Please note that some brokers may already have activated leverage on accounts. In such cases, you can increase or decrease its value from settings or by emailing the brokerage.

Benefits of Using Leverage

Despite its risk, leverage trading offers a handful of benefits to traders. Let’s go through some of them in detail.

Buying Power

Leverage trading provides traders with additional purchasing power. This allows investors to enter positions with a larger value than their original capital, allowing them to potentially earn higher profits.

Higher ROI

Since leverage amplifies the potential profits on a trade, it provides traders with the opportunity to earn higher returns on their investments. Of course, this also means that there is a higher risk of loss, which is why it is essential to use leverage with caution and proper risk management.

Flexibility

Leverage provides traders with more flexibility in their trading strategies, as they can take advantage of price movements with smaller investments. It also allows traders to diversify their portfolio and take on multiple positions simultaneously.

Demerits of Using Leverage

Receiving a margin call can be a scary nightmare for many. Using leverage can get you one.

Risk, Risk and More Risk

The use of leverage in trading can magnify both potential gains and losses. While it can increase your buying power, it also increases the risk of losing your entire investment if the market moves against you.

Emotional trading

Trading with high leverage can lead to emotional trading, as the potential gains and losses become much larger. This can lead traders to make impulsive and irrational decisions, which can result in significant losses.

How Does Leverage Crypto Trading Work in Derivatives?

Derivatives markets are complex, with various types of trading such as options, futures, and perpetual contracts. Options involve agreements between traders to sell an asset at a predetermined time and price, but the contracts are non-binding. Futures are similar, but contracts are legally binding, meaning the parties must execute the trade on the set date. Perpetuals are a type of futures contract that does not have a settlement date.

Leverage trading with perpetual contracts differs significantly from margin trading. Platforms that allow margin trading may limit the amount of leverage to reduce risk and protect customers’ assets. However, perpetual contract markets are highly speculative, and traders can find leverage ratios as high as 100x, 125x, or even 200x. Therefore, perpetual contract trades are even riskier than margin trading.

USA Regulations for Crypto Leverage Trading

Trading cryptocurrencies with leverage can be a profitable but challenging task, requiring experience and risk management tools. Due to the complex nature of this trading, it is strongly regulated by governments worldwide, particularly since the 2008 financial crisis. However, the volatile nature of the crypto industry and the potential for sudden price changes make it even riskier than traditional trading.

Additionally, the 24/7 trading in the crypto market allows for the possibility of market manipulation, further reducing its reliability in the eyes of regulators. As a result, some countries have banned certain types of leveraged trading, such as margin trading, and the US has strict regulations in place for crypto leverage trading.

Here are some of the criteria that you must meet in order to trade crypto at most exchanges: