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Leverage: How To Use It Responsibly

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2022-10-31
Leverage: How To Use It Responsibly

Leverage trading is immensely popular in cryptocurrency trading. In fact, leverage trading has reached popularity levels never seen before in any other market. What is leverage trading? In this article, we explored the concept of leverage and how it works. This article will focus on how leverage can help you manage risk.

Leverage: A double-edged sword

Let's do a quick recap. It begins with the understanding that there is risk involved with every opportunity. With trading on leverage, there is no difference. The first and most obvious risk is the fact that leverage trading is a double-edged sword. While one can make larger profits, the losses will also be larger. In addition to that, the higher your leverage level is, the closer your liquidation price lies, which would mean if hit, you lose your entire position and, in some cases, your entire account balance.

What if leverage can actually reduce your risk?

If you have done your research, then you know that trading leverage is risky. But what if leverage can actually help you manage the risk instead of increasing it? Right now, you might think: "Mike, I have never heard something as ridiculous as this." But have you considered the fact that keeping all of your funds in one exchange, for example, is more risky than storing your crypto assets offline? This is where the mechanics of leverage can actually work in your favor.

By using leverage, it is possible to enter a position size larger than what you have available in your exchange account while keeping your overall risk management in check. What does this mean? Imagine the following scenari

Scenario 1

You have a portfolio size of $20.000. This portfolio is spread out over multiple exchanges, and a part is stored on a hardware wallet. You have decided that per trade, you are willing to risk 3% of your account size, which equals to a $600 dollar risk per trade.

Now, you decide to trade on Bitget where you have $5.000 worth of assets. You identify a trade setup that gives you a 3% stop loss. In order to take that risk, you would need a position size of $20.000. This effectively requires you to leverage your account holdings to 4x leverage in order to meet your desired position size, yet you take the same risk as you would should you have your whole portfolio located in one place.

Scenario 2

A different scenario follows. Your asset allocation is exactly the same as in scenario 1. A portfolio worth $20.000, and $5.000 on Bitget. You identify a trade setup with a 1.5% stop loss. This allows you to effectively increase your position size while honoring your original risk appetite. In order to risk $600, you would now need a position size of $40.000. This requires you to use a leverage size of 8x. Even though you are now trading on considerably high leverage, you maintain your original risk tolerance.

Be responsible

In the above scenarios, you can use leverage mechanics to expose your full portfolio at no additional risk. In fact, it is actually reduced risk as you would not expose all your funds in one place. However, do not forget that with increased leverage, your liquidation price also draws closer. If you get liquidated, you will lose your entire position or even your entire account balance. So it is up to you to find a good balance in how much exposure you need in order to trade comfortably and never risk more than you can afford to lose.

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Disclaimer:

The information provided above is not financial advice but for educational and entertainment purposes. Please do your own due diligence or consult a financial advisor before investing in any digital assets.

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