Leverage trading is no longer a new game in the crypto space. It allows traders to trade with borrowed funds, thereby reducing the initial amount they are to contribute. Theoretically, it helps traders maximize their returns by trading with larger funds or positions than they would ordinarily have. However, due to its volatility, leverage trading can pose significant consequences in the crypto space.
Unlike traditional trades, it has more significant risks, which everyone who desires a good trading experience should avoid. There are five reasons why leverage trading is a fool’s game-easy to get REKT, i.e. you may end up losing more than what you invested. This article will put you through the five reasons and why you should apply caution to engaging in leverage trading.
5 Reasons Why Leverage Trading is a Fool’s Game
Before we look into the reasons, let’s first understand what the process entails. Leverage trading magnifies investment profit through investment strategies like borrowing money (margin trading), leveraged ETFs, and Options trading.
Margin Trading: This makes use of borrowed money to sell or buy short securities; it takes place in a margin account. This is a type of brokerage account where your brokerage firm lends you cash, known as a margin loan. They, in turn, use the account as collateral for buying and selling short securities. If, for instance, you bought in a cash account $30 stock and the price appreciates to $45, you will make a 50% (since the additional $15 is 50% of $30). But if you bought in a leverage account paying $15 and borrowed $15 from your broker. You will earn 100% of your capital ($15) and owe your broker $15 and its interest.
Options Trading: This refers to the buying and selling of contracts that allow you to sell or buy the underlying asset. It allows you to buy or sell at a fixed price(strike price) on or before a specified date. These underlying assets include ETFs, fixed income products, commodities, or foreign currencies. For instance, if you buy ABC Call contract for their shares, believing that it will appreciate before the tenure ends.
But what happens when the price depreciates at the end of expiration instead of appreciating?
Leveraged ETFs: This tracks broad indices, including sector-specific, linked commodities
Currencies or other benchmarks. For instance, a 2times leveraged SP 500 ETF will target to deliver twice the return on investment of the SP 500 index. This implies that this ETF will lose 2% for each 1% loss in the index.
However, whether it’s margin trading, leveraged ETFs, or Options trading, the following reasons make leverage trading a fool’s game.
- You can lose more money than you have invested: For instance, if after buying the stock believing that the price will appreciate upon investment expiration and it drops ‘out-of-the-money.’ This normally results in a 100% loss of investment funds.
- You are not entitled to an extension on the expiration of your investment,; trading and options trades have no guarantees. There is no limit to the maximum price for a stock in options trading; this exposes the option writer to unlimited potential losses. Option writers are sellers of options contracts.
- As a leveraged trader, your broker may give you a margin call on short notice. This requires you to deposit additional cash or securities in your account to cover market losses. They can also increase their margin requirements at will without notification.
- Since you are trading on leverage, your brokerage firm can sell all or some of your securities without your consent. This will enable them to offset your margin loan. You are not allowed to decide or choose the securities they sell your accounts to pay off your loan.
- When the value of your securities is affected by depreciating stock prices, you may be mandated to sell your securities. The falling rate determines whether you will be asked to sell off some or all you have.
Is The Gain Worth the Risk?
The risks of leverage trading can be very dangerous, as it could lead to a potential loss of not just part but all your funds. It’s even possible in some cases to lose more money than what you have available to invest. This is typical when crypto volatility plays out, trading leverage on a highly volatile asset is simply a call for disaster.
However, this article is not meant to discourage you entirely from leverage trading, but it serves as an eye-opener to some important risks. It’s also a call for you to trade with caution; you can double your gain. Always invest only what you can afford to lose.