What is leverage in crypto trading? 4 ways to manage your risk when trading with leverage

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Leverage is a quick way to earn more when trading. With this, you can significantly increase your trading profits. Of course, that sounds intriguing; however, it is a double-edged sword that not only benefits but also causes a nightmare for many newbie crypto traders when not handled properly. For this reason, you need to know what leverage is, how it works, and how to manage your risk when using it.

What is leverage in cryptocurrency?

Leverage allows you to gain more exposure to the crypto market than the amount you deposit to open a trade. It is more like using borrowed funds to open trades while providing only a fraction of the total trade value.

Traders and investors use it to increase the amount they have in their wallet so they have more capital to trade with. Leverage is given by the broker or exchange you use, and the amount of leverage that can be used for trades varies between exchanges and trading instruments.

How does crypto leverage trading work?

Leverage is usually represented by ratios. Exchanges usually offer leverage options between 1:1 and 1:500, or even more. Using 1:100 leverage means you can execute a trade 100 times (100x) your initial margin. The leverage ratio for a position is determined by comparing your total market exposure with your deposit, also known as margin.

So let’s say you open a buy position on BTCUSDT with $100. If the price increases by 5%, your profit will also increase by 5%, which means you will have $105. If you use 10x leverage, your position will be multiplied by ten. So if you have an increase of 5%, the result will be multiplied by ten (the leverage effect), which means that you will have 50% profit instead of the 5% that you had without leverage.

On the other hand, if the trade goes against you by 5%, you will also lose 50% of that position, and if it goes against you by 10%, your position will be liquidated and you will lose your money.

Let’s explain it another way. If you have $1,000 in your wallet and want to enter a position on DOGE/USD worth $10,000, you can leverage it 10x, which means your margin will be multiplied by 10. However, if you have less than $1,000, say $500, you can also increase your leverage to 20x, and you can still enter the $10,000 position.

Just like in the first example, trading with more leverage also means that your potential losses are magnified, and if the trade goes against you, you will lose significantly more than you would have lost without leverage.

Ways to manage your risk when using leverage

Now that you know how leverage works, it is necessary to manage your risk when using it. Below are ways to do this:

1. Determine your risk per trade

Before deciding on the amount of leverage you intend to use, you must first determine the percentage of your capital you intend to risk per trade. Common advice from many expert traders is to risk no more than 3-5% of trading capital per trade, no matter how promising. This is because no trade has a guaranteed outcome and excessive leverage will put your portfolio balance at risk if the trade continually goes against your predictions.

2. Use Stop Loss and Take Profit targets

Stop-loss and take-profit orders are types of market orders that help traders control how much they gain or lose on a given trading position. The stop loss helps limit your losses when the price reaches a certain point that you have predetermined, while the take profit secures your profit when the price reaches a certain point.

Stop-loss and take-profit orders will help you stay in control, regardless of the market situation or the level of leverage you use. Think of a case where you have a risk-reward ratio; let’s say you risk 2% of your account per trade, regardless of the leverage you use. Using a stop loss that stops the trade when the market goes against you by 2% keeps you in the game since the loss would still play out as expected. If you don’t use stop loss, one bad trade can cost you a lot of money.

3. Keep a separate account

The crypto market is unpredictable; even with the best analysis, the market price could still go against your predictions. Thus, you cannot always be precise, so it is dangerous to take advantage of all the amounts you have in your account. This can affect your emotions since you don’t want to lose your entire wallet. For this reason, it is better to keep a separate account for leveraged trading by allocating a certain amount of your capital to it.

4. Try to take advantage of a simulated account

You can’t control the amount of leverage you use if you don’t understand how it works. One of the best ways to understand how it works is to try it out on a simulated account as it comes with no risk.

Trading on paper for a while will show you how leverage works, and with that, you will be able to know what amount of leverage you are comfortable using. A paper trading account or a practice trading account helps you trade with a simulated account the same way you would with a real account.

The leverage you use will affect your profits and losses the same way it would in a real account. So, it can help you know what leverage you are comfortable with or if you are not even interested in using leverage.

Leverage amplifies your profits and losses

Leverage can help you make more profit in less time than the average trader who uses no leverage. In the hands of a skilled and risk-conscious trader, this could be a reasonable advantage. The same is very risky and can lead to major losses and even account liquidation for negligent traders.

The effect this can have on your account is huge. To do this, you have to take your time to fully understand how it works and ensure that its use is always mastered by applying the advice we have given you.

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