Author: Catherine
Created:
In cryptocurrency, leverage means borrowing capital to increase the size of your trading position beyond your initial investment. For example, with 5x leverage, your $1,000 capital allows you to control a $5,000 position. While leverage amplifies potential profits, it also significantly magnifies potential losses and can lead to forced liquidation if the market moves against your position.
How Leverage Works
- Margin: You use your own capital, known as "margin," as collateral to borrow additional funds from a trading platform.
- Larger Position: The borrowed funds allow you to open a much larger position in a crypto asset than you could with your own funds alone.
- Leverage Ratio: Leverage is expressed as a ratio, like 2x, 10x, or even 100x, indicating how many times your initial investment can be multiplied.
- Amplified Outcomes: A small price movement can result in a much larger gain if the market moves in your favor, or a much larger loss if it moves against you.
Example of Leverage
- Scenario: You have $1,000 and believe Bitcoin (BTC) will rise.
- With 5x Leverage: You can control a $5,000 BTC position.
- If BTC Rises 10%:
- Without Leverage: You would gain $100 (10% of $1,000).
- With 5x Leverage: Your $5,000 position increases by 10% to $5,500, netting you a $500 profit, which is a 50% return on your initial $1,000.
Risks of Leverage
- Magnified Losses: Just as profits are amplified, losses are also magnified, potentially wiping out your initial investment quickly.
- Margin Calls: If the market moves against your leveraged position, you may receive a "margin call," requiring you to deposit more funds to cover the losses and maintain your position.
- Liquidation: If you cannot meet a margin call or the market moves too far against you, the exchange can automatically close your position to prevent further losses, known as liquidation.
