A trap for the beginner. Why you shouldn’t trade with leverage
Beginning traders in the digital asset market often use borrowed funds to increase their potential profit, disregarding the high risk of losing their own deposit. How not to make such mistakes and secure your money.
- What is leverage
- What is the difficulty?
Many novice traders try to use leverage to trade cryptocurrency, as it allows them to significantly increase their potential profit. However, using leverage comes with a high risk of losing your deposit. To understand how to use this tool, you need to understand how it works.
What is leverage?
Leverage is a loan of money from a broker to open a position. For example, having $1,000 deposit and x2 leverage it is possible to open position for $3,000. When borrowing money from broker, it is always trader’s money as a collateral, because in this way trading platform insures itself from possible losses. Also note that the broker issues a loan with an interest rate, which is usually higher than the average interest rate at banks.
If an open position with a leverage of $3,000 results in a 25% loss, the trader will lose most of his deposit ($750). The trader loses $250 from his own $1,000 and another $500 of losses from borrowed funds ($2,000). Moreover, the trader’s loss will be a larger amount, since it is also necessary to take into account the interest rate on the loan.
If the open position shows a 25% profit, the trader will get $750 ($250 from his deposit and $500 from the borrowed funds) minus the interest rate on the loan. It means that in case of successful transaction trader will increase his capital by 75% and in case of unsuccessful transaction he will lose 75% of his funds.
What is the difficulty
Leverage is a complex financial tool that every trader can use, but it requires a lot of experience in trading digital assets, Currency.com cryptocurrency exchange financial analyst Mikhail Karkhalev explained. According to him, the main mistake beginners make when working with leverage is the excitement and desire to earn a lot and at once.
“Great leverage can really bring incredible profits, but if you try to work with leverage on a demo account for the sake of interest, you will see that with a leverage of 100x the deposit can go, literally, in a matter of seconds,” the analyst noted.
Karkhalev did not recommend traders too impulsive and reckless to use the leverage more than x5.
A trap for beginners
Often novice traders use borrowed capital to make transactions, because they have a small deposit, and they want to earn a lot and now, said Cryptorg CEO Andrei Podolyan.
“This is a big mistake. First, you need to learn not to lose,” the expert added.
According to Podolyan, it is possible to start trading with small leverage after six months of trading without losses. The expert believes that one of the advantages of the leveraged trading is the possibility to profit from the falling markets. Also the borrowed funds may be used for hedging positions on the spot market, Podolyan added.
Author: Alexei Korneev