Leverage trading existed long before the invention of cryptocurrency. However, this high-risk trading strategy has had a disproportionate impact on the prices of digital assets. Some critics argue that leverage trading is one of the primary causes of cryptocurrency price volatility.
Despite the controversy surrounding crypto leverage trading, many exchanges continue to provide this service to cryptocurrency traders, nowadays you can even automate leverage trading using robots such as https://trustpedia.io/trading-robots/. While people have engaged in crypto leverage trading, newbies must fully understand the risks before implementing this strategy.
What Exactly is Leverage Trading?
Using a debt to purchase an asset held as an investment is called leveraging. Leverage trading allows investors to gain more exposure to an investment than they could have afforded if they had only used their available cash.
Leverage increases a position’s upside, downside, and asset returns. And this increased volatility raises an investor’s risk since the investment’s leverage amount determines the additional bet. In addition to the increased risk, an investor must pay the lender for borrowing money. Considering the risks involved in leveraged trading, conducting it on the site is advisable to avoid unnecessary loss.
When an investor uses leverage, a given increase in the price of their asset results in higher profits, the same logic applies when the asset’s price falls, resulting in more significant losses for the investor. Essentially, the multiples of exposure relative to the investor’s equity measure the amount of leverage.
For example, if an investor has $100 and a share of Apple costs $100, they could purchase one share without using leverage. Alternatively, for a total of $1,000, that investor could borrow $900 to use as leverage. The investor now has ten times the leverage amount on their Apple investment, allowing them to purchase ten shares rather than one.
What Motivates Investors to Use Leverage?
Investors who are highly confident in an investment opportunity will typically use leverage. If the price moves in their favor, the leverage amount allows investors to make a significant profit quickly. A successful leveraged trade can generate a massive return for an investor in a brief period with relatively low capital requirements.
Because leverage is risky and costly, it is unsuitable for a long-term investment strategy. The borrower’s fees will reduce the return on their investment over time. Furthermore, if the trader holds the position for an extended period, the investor will likely face a margin call. If a margin call occurs on the investment, the investor may lose their entire investment.
Leveraged investments typically disregard the asset’s long-term investment potential. Instead, they seek to profit from significant short-term events with considerable price implications. For example, a company’s earnings report may significantly move the stock price, creating an opportunity for leveraged investors.
Bitcoin does not have earnings reports, but it has similar isolated events. For example, currency legislation can potentially move the price quickly and significantly. Furthermore, companies adding Bitcoin support or billionaires investing in the currency could move markets and provide opportunities for leveraged investors.
What Effect Does Leverage Have on Bitcoin Markets?
Investors in Bitcoin markets frequently use leverage. Highly optimistic investors or assuming that market-moving news is about to be announced typically engage in leverage trading.
Significant market moves exacerbate when many investors hold leveraged investments in the same asset. If the price falls, many leveraged investors will face margin calls. And this forces them to sell to close their position and repay their debt. As they sell, the price falls further, resulting in additional margin calls.
At the market level, the presence of leverage increases the volatility of assets. Because its price is less predictable, increased volatility harms Bitcoin’s ability to function as a store of value. Individually, leverage raises risk and increases the possibility that an investment will become completely worthless.