This week are going to explain to you what leverage and liquidation levels are for trading. We usually hear the word ‘leverage your trades’ but what actually is leveraging a trade?
Imagine you want to buy a 20-dollar shirt but you only have 2 dollars. You ask the salesperson to lend you the shirt for a week and then you will return it and for this, you are ready to pay 2 dollars.
This in simpler words is playing on margin or in other words “leverage”. Leverage helps a person purchase something that is out of his pay with a promise to return it after a certain time.
Leverage ranges from 2x to 10x and even 125x in forex markets!
Trading on leverage is done in traditional and crypto markets. Crypto market trading on leverage Is usually known as margin trading. In this, the trader usually puts his/her assets as collateral to buy more of the security. This should usually be used by traders who have been in the game for a long time and have experience. This is advised as with the higher chances of returns comes a higher risk of losing more money in the trade. Hence, a trader should be well aware of the both pros and cons when entering a trade.
The pros of margin trading can be higher profits as your ticket size increases, and the convenience of a trader increases as he does not have to deposit funds every now and then. Traders can divide their risk by entering multiple trades at a point of time with comparatively lower funds in the kitty.
The major disadvantage of trading on leverage is the higher risk it entices you to take. Leverage makes a trader take a risk higher than their capacity which may often lead to bizarre losses which should be avoided at all costs. A strict stop loss should be followed when trading on leverage.
Coming to liquidation levels. A liquidation level in simple terms is a level or percentage that when hit the existing positions taken by a trader automatically exit. This works as a protective tool when trading on margin as traders often forget to square off their position or do not leave a losing trade. This protects the exchange against any mishaps.
The levels are decided by the exchange and traders’ balance. The trader can continue his position in case of an influx of funds by the trader if he/she wants a bigger margin of safety and believes in the trade.
As a result, traders should keep in mind that margin trading is an effective tool to multiply your profits and get the various benefits it offers however, everything comes with cons on its own. The higher risk and the thrill of an opportunity to earn you more profits make the trade very risky and a very high chance of default. The liquidation level tool comes in very handy and hence should be used by the trader and exchange both to minimize default risks. The highly volatile crypto markets make it a very important tool.