Leverage Trading Explained:
In the realm of cryptocurrency, several exchanges offer leverage trading, enabling traders to access significantly higher amounts of capital than they possess. This is often showcased with attractive promises like "100x leverage," indicating that a trader can open positions up to 100 times the value of their original investment.
Distinction from Other Forms of Trading:
Although leverage trading might resemble other trading mechanisms such as margin or futures trading, it has unique features, particularly regarding perpetual contracts (perpetual swaps):
Perpetual Swaps: Different from traditional futures contracts, which have predefined expiration or settlement dates, perpetual swaps do not expire. This permits traders to maintain positions indefinitely as long as they can uphold them.
Funding Fees: A distinctive aspect of leverage trading with perpetual swaps is the funding fee. This fee is exchanged between long and short positions every eight hours. If the funding rate is positive, long positions pay shorts, and the opposite if the rate is negative. This system is intended to align perpetual swap prices with the underlying spot market prices.
Leverage and Liquidation: Utilizing leverage magnifies potential profits and losses. A vital aspect to grasp is the liquidation process. If the market moves adversely against a leveraged position and the trader's margin balance drops below a specific threshold, the position can be automatically closed, or liquidated, to avert further losses.
Addressing Misconceptions About Leverage Use:
Reduces Counterparty Risk: As the FTX saga demonstrates, storing money on an exchange entails risks. Leverage permits traders to deposit lesser amounts, e.g., USD 10,000, enabling effective trading as if it were $50,000, thus reducing the need to deposit significant funds into exchanges.
Hedging: Leverage is a hedging instrument to safeguard other investments or balance a portfolio. By initiating leveraged positions, traders can offset potential losses in their investment portfolio without allocating substantial capital, particularly beneficial for those with spot portfolios looking to guard against significant volatility.
Market Accessibility: Leverage lowers entry barriers for traders lacking access to significant capital, enhancing accessibility for skilled traders since it amplifies potential returns.
Access to More Opportunities: Leveraging enables traders to hold larger positions than their capital would typically permit, facilitating portfolio diversification across a wider range of assets, spreading risk, and heightening the probability of leveraging market opportunities.
In today's market, where price fluctuations exceed 10% daily, investing in complex yield farming schemes appears less appealing. These alternatives resemble margin trading but involve additional complexities. It's wiser to keep capital flexible to leverage current market opportunities fully.
Signing off,
Emporos