Leverage is a fundamental part of the trading process. So, how does leverage trading work? Essentially, leveraging is a form of “borrowing” money in order to meet the necessary financial requirements to open a position. This amount is usually lent by the trader’s broker, usually when using a brokerage account.
Leverage is typically used for margin trading.
In order to get a better understanding of how leverage in trading works, we need to talk about margins and ratios.
Leverage, margins, and ratios all intertwine the following way:
Our trader, let’s call him John, has $5,000 in real money in his trading account. John would like to open a position worth $500,000 on a specific trade. The ratio would look as follows:
In short, the necessary margin for John is 1%. By putting up 1% of the total value of the transaction, the rest will be covered by the leverage.
While trading with money that isn’t technically “yours” might be seen as a massive gamble, the risks are not crazy as you would imagine. Naturally, a knowledgeable trader should not be using his entire trading resources on a single margin. It is also possible to calculate risk, to get a better idea of how much money could potentially be lost if the trade doesn’t go as planned. If John finds out that a 5% loss of his capital is his limit, that’s where he’ll set the stop-loss.
Leverage Trading Crypto
Unsurprisingly, leverage trading is a concept also found in the world of cryptocurrencies. Experienced traders will know that traditional trading and crypto trading will share similar aspects. They also draw parallels when it comes to leverage and margins.
As with traditional trading, the main purpose of leverage trading in crypto is the potential to majorly increase your winnings. Knowing the volatility of the market, a sharp rise is even more common in cryptocurrency markets than in the more stable, albeit slow-growing conventional markets of the stock exchange and Forex.
Is Leverage Trading Recommended for New Traders
There are obvious advantages to using leverage trading. Yes, the potential payoff of a trade that grants you over ten times your initial investment is a mouthwatering prospect. Let’s also not forget that with both stop-losses and take-profit options available, you can protect yourself against complete financial ruin. However, this is still risky for new traders.
Introducing the dreaded margin call!
We’ve stated that leverage trading occurs through a brokerage account. This broker is the individual responsible for providing the additional finances necessary to open your positions and complete your trades. In the event that the trade does not go according to plan, a margin call is instated.
A margin call will require you to refinance the account to make up for your losses. This can come in the form of additional cash deposits or selling securities. Either way, it’s a lose-lose situation for our dear John.
How to avoid reaching the margin call
At the risk of sounding overly dramatic, if you’ve reached the point of the margin call, then you can chalk up your trade as a failed trade. It’s not the end of the world though, you can always bounce back. More importantly, there are precautionary measures you can take to avoid margin calls. Here’s a few pointers to help with your leverage trading experience:
- Depositing extra backup funds into your trading account is the equivalent of putting a safety net on your account’s balance. If your available margin becomes alarmingly low, it’s a safe way of averting disaster.
- Keep a close eye on your positions. All it takes is one open position that you’ve forgotten about to sink you into heavy losses. Make sure you don’t overload yourself with too many unmanageable positions.
- When used intelligently, stop-losses can be your best friend. Even traders have to sleep, and periods of volatility can arise in the most unexpected of times. Place stop-losses on your trades to avoid falling too far down in the red.
Operating leverage is no easy task, and we recommend you find the most reliable brokerage firms who will be able to guide you through the most common pitfalls to avoid. One of the most trusted multi-asset trading platforms that offers generous leverage is SolidusX.
SolidusX allows you to invest safely in stocks, crypto, commodities, and more. If you’re going the way of currency trading, they offer up to 1:30 leverage, and even up to 1:200 if you’re a Professional Client using a Centurion account.
If you prefer to try your luck in the crypto market, SolidusX offers an all-encompassing platform, wallet, and exchange to provide the ultimate crypto trading solution.
As always, we feel the need to remind you to be careful when using leverage to trade. You could end up losing more money than you had originally planned. Done right however, and you could be staring fortunes in the face!