TL;DR

In crypto trading, leverage is the use of borrowed capital to execute trades. Leverage trading can magnify your buying or selling power, allowing you to trade larger amounts. So, even if the initial capital is small, you can use it as collateral to make leveraged trades. While leveraged trading can multiply potential profits, this activity also carries high risks, especially in the volatile crypto market. Be careful when using leverage to trade crypto. This activity can lead to large losses if the market moves against your position.

Introduction

Leverage trading can be quite confusing, especially for beginners. However, before experimenting with leverage, you must understand its meaning and how it works. This article will focus on leverage trading in the crypto market, but much of the information applies to traditional markets as well.

What is leverage in crypto trading?

Leverage is the use of borrowed capital to trade cryptocurrencies or other financial assets. This activity magnifies your buying or selling power, so you can trade with more capital than you currently have in your wallet. Depending on the crypto exchange you trade on, you can borrow up to 100 times your account balance.

The leverage amount is expressed in the form of a ratio, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). This ratio shows the multiple of your initial capital. For example, imagine you have $100 in your exchange account, but want to open a $1,000 bitcoin (BTC) position. With 10x leverage, your $100 will have the same buying power as $1,000.

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

How does trading with leverage work?

Before you can borrow funds and start trading with leverage, you must deposit funds into a trading account. The initial capital provided is referred to as collateral. The collateral required depends on the leverage used and the total value of the position you wish to open (referred to as margin).

For example, you want to invest $1,000 worth of Ethererum (ETH) with 10x leverage. The required margin is 1/10 of $1,000. This means you only need to have $100 in your account as collateral for the loan funds. If you use 20x leverage, the margin required will be lower (1/20 of $1,000 = $50). However, please note that the higher the leverage, the higher the risk of liquidation.

In addition to the initial margin deposit, you must also maintain a margin threshold for your trades. When the market moves against your position and the margin becomes lower than the minimum threshold, you will have to put more funds into the account to prevent it from being liquidated. This threshold is also known as minimum margin.

Leverage can be applied to both long and short positions. Opening a long position means that you expect the price of the asset to increase. Conversely, opening a short position means that you believe the price of the asset will fall. Although it looks like regular spot trading, the use of leverage allows you to buy or sell assets based on collateral only and not ownership. So, even if you don't own the asset, you can still borrow it and sell (open a short position) if you think the market will go down.

Example of a long position with leverage

Imagine you want to open a long BTC position worth $10,000 with 10x leverage. This means you will use $1,000 as collateral. If the price of BTC rises 20%, then you will earn a net profit of $2,000 (minus fees). This amount is much greater than the $200 you would earn if you traded that $1,000 without using leverage.

However, if the price of BTC falls 20%, your position will decrease by $2,000. Since your initial capital (collateral) is only $1,000, a 20% drop will result in liquidation (your balance going to zero). In fact, you can be liquidated even if the market is only down 10%. The exact liquidation value will depend on the exchange used.

To avoid being liquidated, you must add more funds to the wallet to increase the collateral. In most cases, the exchange will send you a margin call before liquidation occurs (for example, an email telling you to add more funds).

Example of a short position with leverage

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

Assuming that the current price of BTC is $40,000, you borrow 0.25 BTC and sell it. If the price of BTC drops 20% (down to $32,000), then you can buy back those 0.25 BTC for just $8,000. This would result in a net profit of $2,000 (minus expenses).

However, if BTC rises 20% to $48,000, you will need an additional $2,000 to buy back those 0.25 BTC. Your position will be liquidated, because the account balance only has $1,000. Again, to avoid being liquidated, you must add more funds to your wallet to increase the collateral before the liquidation price is reached.

Why use leverage to trade crypto?

As mentioned, traders use leverage to increase their position size and profit potential. However, as the example above illustrates, leveraged trading can also lead to larger losses.

Another reason for traders to use leverage is to increase the liquidity of their capital. For example, instead of having a position with 2x leverage on one exchange, they can use 4x leverage to maintain the same position size with less collateral. This will allow them to use other parts of their money elsewhere (e.g., trading other assets, staking, providing liquidity to decentralized exchanges (DEX), investing in NFTs, etc.).

How to manage risk on leveraged trading?

Trading with high leverage does require less capital to start, but increases the chances of liquidation. If leverage is too high, even a 1% price movement can cause huge losses. The higher the leverage, the lower your volatility tolerance. Using lower leverage will provide a greater margin of error for trading. This is why Binance and other crypto exchanges have limited the maximum leverage available to new users.

Risk management strategies such as stop-loss and take-profit orders help minimize losses in leveraged trading. You can use a stop-loss order to automatically close a position at a certain price which is very useful when the market moves against your position. Stop-loss orders can protect you from large losses. Take-profit orders are the opposite. This order automatically closes when profit reaches a certain value. This allows you to secure income before market conditions reverse.

You should now realize that leverage trading is a double-edged sword that can multiply profits and losses exponentially. These trades involve high risks, especially in the volatile cryptocurrency market. At Binance, we encourage you to trade responsibly with your actions. We offer tools such as anti-addiction notifications and cool-down functions to help you take control of your trading. You should always be careful and don't forget to apply DYOR to understand how to use leverage properly and plan trading strategies.

How to use Margin Trading on Binance?

You can use leverage to trade cryptocurrencies on crypto exchanges like Binance. We will show you how to start Margin Trading, but the concept of leverage can also be encountered in other types of trading. Before you start, you need a Margin account. Follow this FAQ article to unlock it if you haven't already.

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

2. Click [BTC/USDT] to search for the pair you want to trade. We will use the BNB/USDT pair.

3. You must also transfer funds to Margin Wallet. Click [Transfer Collaterals] below the candlestick chart.

4. Select the wallet to transfer funds, destination margin account, and coins to transfer. Enter the amount, then click [Confirm]. In this example, we will transfer 100 USDT to a Cross Margin account.

5. Now, .open the box on the right side. Select [Cross 3x] or [Isolated 10x]. Margin in Cross Margin mode is shared between your Margin accounts, while margin in Isolated Margin mode is independent for each trading pair. You can read more about the differences between the two from this FAQ article.

6. Select [Buy] (buy/long) or [Sell] (sell/short) and the type of order, such as market order. Click [Borrow], then you will notice that the 100 USDT we transferred to the Cross Margin account is now multiplied by 3x to 300 USDT.

7. You can buy BNB using leverage by entering the amount of USDT using [Total] or the amount of BNB you want to select using [Amount]. You can also drag the bar at the bottom to select the percentage of your available balance to use. Then, you will see the amount borrowed for this trade. Click [Margin Buy BNB] to open a position.

Note that you will not be able to use your entire available balance, as you will have to pay trading fees. The system will automatically save the trading fee amount depending on your VIP level.

Closing

Leverage allows you to get started easily with a lower initial investment and the potential to generate higher profits. However, leverage combined with market volatility can cause liquidations to occur quickly, especially if you take 100x leverage to trade. Always trade with caution and evaluate the risks before trading with leverage. You should never trade funds that you cannot afford to lose, especially when using leverage.