Cryptocurrency trading is a very profitable activity involving digital currencies (crypto assets). Brokers are one of the main players in this activity, since they are the facilitators to all transactions. Trading involves the buying and selling of currencies based on the fluctuation of their prices in the underlying markets. Leveraged trading is an instrument that can dramatically increase traders’ profits through the use of CFDs.
CFDs (Contracts for Difference) are derivative instruments whose price is based on that of an underlying asset. This implies that open trades are actually contracts with the broker, rather than a one-time acquisition of an asset; and they the price value of this asset.
What is leverage in crypto trading?
Trading cryptocurrencies with financial leverage is, in practice, an instrument that lets traders carry out transactions with more money than what they actually invested in the selected market. This is possible because the broker grants the operator a temporary loan; thus letting him trade with positions greater than the amount of funds available in his account.
Generally, brokers express the leverage they grant through a multiplying factor (or X). This factor shows how much larger a position can be with respect to the actual funds deposited by the operator. This financial scheme allows cryptocurrency operations with leverage in the markets. It is therefore advantageous from several points of view. For example, consider a case when at a given moment, the price of a crypto asset is $5,000. In this scenario, a trader owning 5 coins considers that crypto asset to be bullish and would like to invest 10 coins in it. The amount necessary to open said position would normally be $5,000×10=$50,000. This position would be impossible without leverage, but with a leverage of 2x, it would be possible.
What are the advantages and disadvantages of leverage?
The advantages of leverage are evident: since the capital invested gets smaller, the profitability of the operation increases. However, leveraged trading has risks, so a trader can obtain much greater profits than the initial investment the potential losses increase in the same proportion. Consequently, leverage is not something traders should take lightly and the market should be studied before starting to trade. This is because, in the event of losses, the operator’s positions can be harmed and potential losses will be covered with the available capital in their account.
Beyond the inherent risks associated to this type of financial operations, every trader must recognize that risk management is possible. When it comes to trading with financial leverage, it is appropriate to start with the mandatory monitoring of positions. You also need to know basic concepts, such as invested capital, risk capital, stop loss, etc. As in most cases, maximizing profitability is a matter of balancing potential earnings and risk.
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