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Does Lower Leverage Make Better Sense for Your Trading?

2021-07-29

Leverage is an essential tool across traditional and cryptocurrency markets. It allows for better capital efficiency as traders do not have to lock up entire amounts of capital. Together with futures and options, they help introduce liquidity into the market. Because the use of leverage necessarily increases both potential returns and risks, users must always exercise caution. 

Over-leveraging, or the misuse of leverage, is one of the common reasons why novice traders fail. It is akin to aiming a home run on every swing — the problem with this approach is that it is incredibly unsustainable. Needless to say, a high-risk, all-or-nothing environment where any slight mistake can wipe out a trader’s capital is not the kind of environment we advocate at Binance. 

Mistakes will inevitably happen during trading; no one person or a perfect algorithm can precisely predict every market’s movement. To ensure that mistakes do not eliminate your capital, your self-esteem, and your chance of learning from errors, do not over-leverage. Especially with cryptocurrencies being extremely volatile and unpredictable, over-leveraging can materially damage your odds of success on any particular trade and potentially lead to outsized losses.

At Binance, we believe that all our clients should fully understand the impact of leverage and the circumstances under which it can significantly damage the probability of a profitable trade. We also believe that allowing excessive leverage is not in the interests of our clients, our firm, or our industry.

How does high leverage impact your trades?

Not only does leverage amplify your losses, but it also amplifies your transaction costs. The associated transaction costs of using high leverage can gradually drain your capital. 

Let’s say you have deposited 500 USDT in your Binance futures wallet. You decided to open a 100x leverage position with your 500 USDT deposit, giving you a total exposure of 50,000 USDT (500 x 100). Considering the standard taker fee of 0.04%, the cost to open this position will be 20 USDT — that is 4% of your account!

With one trade and the market not even moving yet, you already have to account for 4% in calculating your overall P&L. Therefore, your account balance shrinks if your position goes wrong, thereby increasing your effective leverage. Furthermore, when trading perpetual contracts, you would incur funding fees that are charged every eight hours. Assuming a low funding fee of 0.01% (or 0.04% daily), this would translate to an additional 20 USDT daily deduction from your account balance. 

Therefore, traders must consider the associated cost of using high leverage as it may have a profound impact on your account over time: the higher your leverage, the higher your transaction cost as a percentage of your trading capital. 

This demonstrates how excessive leverage distorts the likelihood of your trade being successful. This distortion is caused by the interaction of leverage and transaction costs (commissions and funding). In other words, high transaction costs as a percentage of your trading capital can shift the odds against you.

If your margin is smaller than 100x of your position’s market value, your chances of losing start to rise extremely quickly. This is because expenses chip away at your margin capital, resulting in a greater likelihood of liquidation. 

What measures have we taken to avoid this from happening?

Binance is the first cryptocurrency exchange to establish a Responsible Trading program, devoting resources to further educating users on the dangers of trading and introducing safety measures including leverage limits, anti-addiction limitations, and “cooling-off” suspension features.

We are engaging more users and are conscious of greater responsibility in safeguarding them as global adoption accelerates. However, we would like to remind you that the cryptocurrency market is risky, and all users who want to engage must exercise care and self-assessment. Beginner users should use caution and engage in responsible trading practices. This is why we require users to take compulsory quizzes and complete training videos when users sign-up for futures trading.

In addition, we also limit our maximum leverage for new accounts to expand consumer protection further. On July 19th, 2021, Binance Futures started limiting leverage levels up to a maximum of 20x for accounts opened within 30 days.

This new rule was further enhanced on July 27th, where we decided to further extend the leverage limits for new accounts from 30 days to 60 days. This means new futures accounts cannot access leverage exceeding 20x within 60 days of registration

The majority of users on Binance do not use high leverage levels, and a number of our users do not utilize any leverage at all. Nonetheless, this new measure is an additional way we can help protect new users on our platform.

How to Pick an Appropriate Leverage Level

We encourage you not to use the maximum allowable leverage as a matter of habit when trading. Our maximum allowed leverage provides flexibility when you need it, but you should always opt for a conservative amount of leverage in the normal course of trading.

Before deciding on a degree of leverage, investors should examine generally recognized guidelines. The three most basic principles of leverage are as follows:

  • First, maintain low levels of leverage.

  • Use stop-orders to reduce downside and protect capital.

  • Limit capital to 1% to 2% of total trading capital on each position taken.

Traders should use a leverage amount that suits them. For example, if you're conservative or new to cryptocurrency trading, a 5x or 2x leverage would be appropriate.

An appropriate leverage amount is determined by a trader's expertise, risk tolerance, and comfort level while trading in cryptocurrency markets. Novice traders should always use caution as they learn how to trade and gain expertise.

Final Thoughts

It's not only the users who bear responsibility. Every exchange must assume responsibility for educating its users as much as for allowing users to utilize their platform services and features. 

Binance will continue to invest efforts and resources into both aspects of platform security and risk management mechanisms to secure and protect our users and their fund. Furthermore, as regulatory frameworks for our young crypto industry continue to shape up worldwide, Binance is taking concrete steps in our commitment to compliance and working with regulators to protect users, encourage innovation, and build a fair and sustainable industry.

Learn some tips on how to get started with Responsible Trading on Binance.