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What is leverage and how to make money with it – we analyze it with examples
In this lesson you will learn:
- What is leverage?
- What is margin trading?
About Currency.com and Petya with €100
Petya learned that cryptocurrency margin trading can bring a quick income. Petya decided to buy bitcoin.
The price of bitcoin at the time of his interest was €8931. Petya believes that it will continue to grow and would like to buy 10 bitcoins right now. But the full price of the position for 10 bitcoins will be €89,310. Firstly, this is a large amount of risk. Secondly, it’s just a big amount, and Petya would like to start with €100.
There is no money, but Petya would like to buy bitcoins . What to do? On Currency.com, on the main trading screen Petya looks for the Bitcoin/EUR pair . Clicks Buy and selects trading with leverage in the upper left corner.
With €75 in Petya’s account, the platform offers 20:1 leverage – for every €20 in a position, he needs to invest €1 from his account, and Currency.com will provide the rest. The deal (the amount Petya can buy bitcoin for) will be €1,500. The down payment – his money for the deal – will be €75.03. Petya will receive about €1425 from the exchange. Trading fee €1.12, leverage fee -0.0100%. With this investment, Petya will buy 0.167 bitcoins.
Let’s say bitcoin soon rose to €10,000. Having sold his 0.167 bitcoins, Petya will receive €1670. We subtract €1425 from them – this amount of leverage must be returned to the crypto exchange. Petya will be left with €245, of which €75 is Petya’s money and the remaining €170 is profit, from which commissions must be deducted.
If you increase the leverage to 50:1, then the size of the transaction will also increase – up to €3,754.96, and Petya can already buy 0.42 bitcoins. Petya’s prepayment will be €93.87, the trading commission will be €2.81, the commission for leverage will be -0.0100%, the amount of leverage itself will be €3661. With this amount of leverage and Petya’s funds, a mandatory installation of a guaranteed stop loss will be required – a tool that will not allow you to go into the red. When it is triggered, a commission of 0.5% is charged – but only when it is triggered.
Let’s take the same example, when bitcoin soon rose to €10,000. By selling his 0.42 bitcoins, Petya will receive €4,200. From them we subtract €3661 – what needs to be returned to the exchange. Petya is left with €539, of which Petya’s contribution is €93.87 and the trading commission is €2.81. Subtract more commission for leverage and stop loss, and there will be about €440 profit.
Leverage of 100:1 will require Petya more money than the €100 he has – approximately €112 and €5.6 commission. Therefore, such leverage is not available for Petya. Theoretically, we can calculate how much Petya could get if he had more money.
The size of the transaction in this case will be €7498.56, and Petya will buy 0.84 bitcoins. Prepayment of €112.47, trading fee of €5.62, leverage fee of -0.0100%, leverage of €7386.08, stop loss fee of 0.5% when triggered.
With a bitcoin value of €10,000, Petya will receive €8,400 when selling 0.84 bitcoins. Of these, we will return to the exchange the amount of leverage of €7498.56, pay about €6 commission and take away Petin’s contribution of €112.47. As a result, about €783 of profit will remain.
What Petya needs to remember
1) Margin trading on a crypto exchange can increase both profits and losses. If the value of bitcoin falls, then Petya’s losses will grow in the same way. Let’s say the bitcoin rate fell to €5,000. With a leverage of 20:1, selling his 0.167 bitcoins, Petya will receive €835. From them we subtract €1425 (this amount of leverage must be returned to the crypto-exchange) and commissions. Taking into account commissions, Petit’s losses will amount to more than €590.
2) Sudden market movement may affect current trades. Petya needs to look at the levels of capital to prepayment ratio:
If the prepayment level exceeds 100%, then there is no need to deposit additional funds, because Petya has enough funds to keep his positions open.
If the prepayment level drops to 80%, Petya will receive a margin call.
If the prepayment level is 50% or less, the platform may close Petya’s positions without warning until his margin account reaches approximately 80% of equity again.
3) With only €100, Petya will not be able to buy 10 bitcoins even with leverage. Cryptocurrency trading on Currency.com allows you to get leverage up to 100:1. But with Petya’s contribution of €100 and the price of €8931 of bitcoin, 100:1 leverage would not be enough even to buy one bitcoin. Petya’s contribution must be more than €1000.
4) The amount of commission for leverage on Currency.com depends on the group of the tokenized asset.
5) Leverage fees apply to leverage orders rolled over overnight at market rates and are also charged on days when markets are closed. These fees are always clearly shown. In addition, leverage fees are charged every 8 hours for ETH/USD, BTC/USD, ETH/EUR, and BTC/EUR and every 24 hours for other tokenized instruments.
6) A guaranteed stop loss allows you to avoid unforeseen losses in case of volatile price changes. It excludes the execution of an order at a price different from the value specified in the previously set condition.
If Petya has set a guaranteed stop loss and this condition is met, then a commission is deducted from Petya’s account. Its size depends on the asset and is indicated directly in the order editing window. The commission for making a transaction using leverage is included directly in the financial result of the transaction.
7) The prepayment amount for the Guaranteed Stop Loss condition is calculated as follows :
Prepayment Amount = Trade Volume / Leverage Size + Trade Volume * GSL Fee
Trade Volume = Quantity of Asset * Price at Order Placement
8) In the case of ETH/USD, BTC/USD, ETH/EUR and BTC/EUR with leverage of 1:50, 1:100, the guaranteed stop loss is set automatically and is calculated by the formula :
Prepayment Amount = (Price at Order Placement – Price Level) * Quantity of Asset + (Price at Placement of Order * GSL Fee * Quantity of Asset)
9) P&L – profit or loss on pending transactions in the “leveraged trading” section (margin trading on the exchange), is calculated as follows:
P&L = Quantity * (Current Price – Transaction Price)
P&L of a wallet is equal to the sum of profit or loss on all current transactions in this wallet
10) If Petya buys leveraged tokenized bonds, he will receive full dividends on them. Dividends on tokenized assets are paid both when they are purchased without leverage, and with it.
11) Let’s say Petya doesn’t know what cryptocurrency margin trading is. If Petya had not used Currency.com’s leverage and traded only his €100, he would have bought 0.01119695 BTC. Petya’s profit if the coin grew to €10,000 would be only about €11 euros.
12) The difference between trading with leverage and the usual one for Petya is that in the first case, he cannot withdraw the assets bought with the money of the crypto-exchange, or do whatever he wants with them – the “creditor” will not allow it. And in the second – he is the owner of all his money.
13) When trading with leverage on the Currency.com platform, Petya can optionally use wallets : USD.cx , EUR.cx , GBP.cx , BYN.cx , RUB.cx , BTC and ETH . In order to understand the terminology that will have to be encountered in this case, we have prepared a brief memo:
- Funds is the balance of all completed transactions, as well as the amount of equity, excluding P&L, of pending trades in Leveraged Trading.
- P&L is the profit or loss on pending trades in Leveraged Trading.
- Equity = Funds + P&L. This indicator reflects the amount of funds deposited, (un)realized profit or loss, minus commissions charged and withdrawals made.
- Reserved – this is the amount of funds taken as an advance payment for any orders in the Trading mode with leverage, as well as for limit orders in the trading mode.
- Available = Capital – Reserved. This is the amount of funds that are currently available for withdrawal.
- Equity = Available + Reserved = Equity + P&L.
14) Trading with leverage is a kind of speculative operation with cryptocurrency on a crypto exchange. Margin trading in shares may differ from it only in the amount of available leverage. At the moment there are more than 5100 cryptocurrencies (most of them are non-competitive) and about 20,000 cryptocurrency exchanges. And if a year ago not even all major platforms offered to trade with leverage, today it is more and more difficult for them to compete without this service.
15) Leveraged trading is inherently riskier than conventional trading. And when it comes to cryptocurrencies, the risks are even higher. This strategy is not suitable for beginners, but if you still want to try it, it is better to start with small bets. The ability to analyze charts, identify trends, and identify entry and exit points will not eliminate the risks associated with margin trading but will help you better anticipate them.