TL;DR

In cryptocurrency trading, leverage refers to the use of borrowed capital to make trades. Leveraged trading can increase your buying or selling power, allowing you to trade larger amounts. Therefore, even if your initial capital is small, you can use it as collateral to make leveraged trades. While it is possible to multiply your profits with leveraged trading, it is also subject to high risk - especially in the volatile cryptocurrency market. Be careful when using leverage for cryptocurrency trading. It is an activity that can generate significant losses if the market moves against your position.

Introduction

The concept of trading with leverage can be confusing, especially for beginners. But before you try leverage, it's crucial to understand what it is and how it works. This article will focus on leverage trading in the cryptocurrency markets, but much of the information is also valid for traditional markets.

What is leverage in cryptocurrency trading?

Leverage refers to the use of borrowed capital to trade cryptocurrencies or other financial assets. It expands your buying or selling power so you can trade with more capital than you currently have in your portfolio. Depending on the cryptocurrency exchange, you can request a loan of up to 100 times your account balance.

The leverage amount is described as a ratio, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). This proportion denotes how many times your initial capital has been multiplied. For example, suppose you have $100 in your account but want to open a $1,000 position in bitcoin (BTC). With 10x leverage, your $100 will have the same purchasing power as $1,000.

You can use leverage to trade different cryptocurrency derivatives. Common types of leveraged trading include margin trading, leveraged tokens, and futures contracts.

How does leverage trading work?

Before applying for loans and trading with leverage, you need to deposit funds into your trading account. The initial capital you provide is what we call collateral. The collateral required depends on the leverage used and the total value of the position you wish to open (known as margin).

Let's say you want to invest $1,000 in Ethereum (ETH) with 10x leverage. The margin requirement would be 1/10 of $1,000, meaning you need to have $100 in your account as collateral for the borrowed funds. If you use 20x leverage, your required margin would be even lower (1/20 of $1,000 = $50). But keep in mind that the greater the leverage, the greater the risk of being liquidated.

In addition to the initial margin deposit, you will also need to maintain a margin limit for your trades. If the market moves against your position and the margin falls below the maintenance limit, you will need to put more funds into your account to avoid being liquidated. This limit is also known as maintenance margin.

Leverage can be applied to both long and short positions. When you open a long position, you expect the price of an asset to rise. On the other hand, opening a short position means you believe the asset's price will fall. While this may look like regular spot trading, using leverage allows you to buy or sell assets based solely on their collateral value and not on your holdings. So even if you don't have an asset, you can still apply for a loan and sell it (short position) if you think the market will fall.

Example of a leveraged long position

Let's assume you want to open a long position of $10,000 in BTC with 10x leverage. In this case, you will use $1,000 as collateral. If the price of BTC rises 20%, you will make a net profit of $2,000 (minus fees), which is much higher than the $200 you would make if you traded your $1,000 without leverage.

However, if the price of BTC drops by 20%, your position will drop by $2,000. Since your initial capital (collateral) is only $1,000, a 20% drop would cause a liquidation (your balance will be zero). In fact, you could be liquidated even if the market drops just 10%. The exact settlement amount varies depending on the broker used.

To avoid liquidation, you need to add more funds to your portfolio, increasing the value of your collateral. In most cases, the broker will send you a margin call before settlement takes place (such as an email asking you to add more funds).

Example of a leveraged short position

Now, imagine you want to open a short position of $10,000 in BTC, with 10x leverage. In this case, you will borrow BTC from someone else and sell it at the current market price. Your collateral is $1,000, but since you are trading with 10x leverage, you are able to sell $10,000 worth of BTC.

Assuming the current price of BTC is $40,000, you borrowed 0.25 BTC and sold it. If the price of BTC drops 20% (to $32,000), you can buy back 0.25 BTC with just $8,000. This would give you a net profit of $2,000 (minus fees).

However, if BTC rises 20% (to $48,000), you will need an extra $2,000 to buy back 0.25 BTC. Your position will be liquidated as your account balance is only $1,000. Again, to avoid liquidation, you need to add more funds to your portfolio, increasing the value of your collateral, before the liquidation price is reached.

Why use leverage in cryptocurrency trading?

As mentioned, traders use leverage to increase position size and potential profits. But, as illustrated in the examples above, leveraged trading can also provide much larger losses.

Another reason traders use leverage is to increase the liquidity of their capital. For example, instead of holding a 2x leveraged position at a single broker, they can use 4x leverage to hold the same position size with smaller collateral. This allows them to use the other part of their money elsewhere (such as trading another asset, staking, providing liquidity to decentralized exchanges (DEX), investing in NFTs, etc.).

How to manage risks with leveraged trading?

Trades with high leverage require less capital to start, but increase the chances of settlement. If your leverage is too high, even a 1% price movement can trigger huge losses. The higher the leverage, the lower your tolerance for volatility. Using lower leverage gives you more room for error when making trades. This is why Binance and other cryptocurrency exchanges have limited the maximum leverage available to new users.

Risk management strategies such as stop-loss and take-profit orders help minimize losses on leveraged trades. You can use stop-loss orders to automatically close your position at a specific price, which is very useful when the market moves against you. Stop-loss orders protect you from significant losses. Take-profit orders are the opposite; they close automatically when the profit value reaches a certain value. This allows you to lock in your gains before the market condition changes.

At this point, it should be clear to you that leverage trading is a double-edged sword that can exponentially multiply your gains and losses. It is an activity that involves a high level of risk, especially in the volatile cryptocurrency market. At Binance, we encourage you to trade responsibly by taking responsibility for your actions. We offer tools such as anti-addiction alert and cooling-off period function to help you maintain control over your trades. It is important to always be very careful. Don't forget to do your own research (DYOR) to understand how to use leverage correctly and plan your trading strategies.

How to use Margin Trading on Binance?

You can use leverage for crypto trading on exchanges like Binance. We will show you how to trade on margin, but the concept of leverage can also be applied to other types of trading. Before we get started, you will need a margin account. Follow the instructions in this FAQ article to create an account.

1. Go to [Trade] - [Margin] in the top navigation bar.

2. Click [BTC/USDT] to search for the pair you want to trade. In this example, we will use the BNB/USDT pair.

3. You will also need to transfer funds to your Margin Wallet. Click [Transfer Collateral] below the candlestick chart.

4. Select the wallet for transferring funds, the destination margin account and the currency to be transferred. Enter the amount and click [Confirm]. In this example, we will transfer 100 USDT to the Cross Margin account.

5. Now select the box on the right. Choose [Crusade 3x] or [Isolated 10x]. The margin in "Cross Margin" mode is shared between your Margin accounts, while the margin in "Isolated Margin" mode is independent for each trading pair. Read more about the difference between the two in this FAQ article.

6. Select [Buy] (long) or [Sell] (short) and the order type, such as a market order. Click [Loan] and you will notice that the 100 USDT we transferred to the Cross Margin account will be multiplied by 3x, totaling 300 USDT.

7. You can buy BNB with leverage by entering [Total] in USDT or use BNB value to buy for [Amount]. It is also possible to drag the bar below to select the percentage of the available balance to be used. You will see the loan amount for this trade. Click [BNB Margin Buy] to open the position.

Please note that you will not be able to use all of your available balance as you will need to pay a trading fee. The system will automatically retain the trading fee amount depending on your VIP level.

Final considerations

Leverage allows you to start with a smaller initial investment and have a chance to generate larger profits. Still, leverage combined with market volatility can cause liquidations to happen quickly, especially if you are using a 100x leverage level. Always trade cautiously and evaluate the risks before taking a leveraged trading position. Never trade funds you cannot risk losing, especially when using leverage.