What is Leverage?
Understanding leverage and how it works
When using leverage you are adding a level of risk to your trades, when you use leverage you are borrowing capital from your exchange to make a trade. This amplifies your buying and selling power and allows you to trade a larger amount of capital than what is in your account. This can be beneficial especially to accounts operating with a smaller amount of capital as it allows them to trade with a larger bank roll. While leverage can multiply your profits, it can also multiply your losses.
Let’s go through an example of how leverage works. Let’s say you have $1,000 in your account and you want to trade ETH, but let’s say you would like to use 5x leverage on this trade. This means you now have $5,000 at your disposal to trade with. Your initial $1,000 is used as your collateral, we will get to how that comes into play in a minute. Let’s say that ETH goes up 25% after you enter the trade, if you hadn’t used leverage, you would have made $250, but since you were using 5x leverage you made $1,250!
Now let’s say you bought ETH with 5x leverage and it dropped 25% from your initial entry, if you hadn’t used leverage you would have taken a $250 loss, since you used 5x leverage you would have taken a $1,250 loss. Not so fast! Since the $1,250 is more than your initial $1,000 collateral for your account, the moment the trade was down more than 20% which is $1,000, your account would have gotten liquidated and you would have $0 and that 25% loss on a trade, just turned into a 100% loss on your account.
This is why there is risk involved in leverage trading, the higher amount of leverage you use, the higher risk you are going to take. However with the right bots, and stop losses set, you mitigate a large amount of your risk involved with leverage and can use it to your advantage.
Let’s say for the example above, your bot had a stop loss set on ETH at 5%, well in that case, you would have taken a loss yes, but it would have been a smaller loss and there is no chance of your account getting liquidated from a 5% drop when using 5x leverage. This is how you can use it to your advantage.