Steemit Crypto Academy Contest / S13W6 - Leverage in cryptocurrencies

Leverage!

This has reminded me of my days in school where i and my friends had to seat down and do a lot of calculations before embarking on any project that will earn us quicker returns on investment.

Sometimes we just pick a textbook and start solving all the exercises to be able to master and understand the different angles to a particular financial question.

This topic on leverage has exposed me once again to the financial world where one needs to borrow to make up his or her capital to take advantage of higher profit in a shorter while compared to when one decides to just do business with his or her little capital.

Some people like me are afraid of borrowing to start up a business due to the inherent charges that one has to pay especially when the business turns south or goes against you. I hate borrowing but one can't run away completely from it.

But it is a nice opportunity to take advantage of in the crypto world seeing that you don't always have all the capital you need at all times. Though risky, but it is still advantageous. Hence, one just have to take a little push to start up.

Well, from my indebt studies of this leverage, i have been able to learn a lot which i will be explaining in due course. Just follow along as i use the contest tips to explore crypto leverage. @starchris @casv and @steemdoctor1 please join me in this contest.

In your own words, what do you understand by leverage?

• From a layman's point of view, leverage means gaining an advantage over something due to the help rendered to you. That help received is called leverage. I am familiar with going to the river to fetch water with big basin. Most times i am alone in the river with no one to assist me to lift the bucket of water up to my head. What i do is, pull the basin close to a wood, use my whole strength to lift it upto the wood, on that level, i can then bend down or kneel down and lift the basin to my head. Sometimes i will be successful but at another time i will just fall along with the basin, hahahaha!

But the wood has provided a leverage anyways.

In most cases, i will be fortunate to see someone to hold the basin on one side, while i hold on the other side and we lift it up to my head. I will be grateful for the leverage received from that person.

Another real life experience is when i go to fetch firewood. After gathering and bunding it, and no one to help, i will just lift one side of it, then bend down to put my head at the middle of the bundled firewood, then push it up. If i am about to fall, i will lean on a tree close by and gain my balance. But may still fall anyways and laugh at myself. The tree has offered me a leverage anyways.

• From a company's perspective, it means the use of borrowed funds in addition to their own funds for investment to earn more returns. Traders use leverages to increase their buying power, thereby increasing the profitability in the process.

I have been opportune to solve some accounting questions where a company owner has a start up capital of $3000 for instance and then a loan of $5000. The loan of $5000 is then a leverage to that man in starting up the company but it goes with interest. Though we treat all capitals (both loan and the capital from the man) as liability to the company, but to the owner, he has a leverage and starting up that company will be much more easier compared to when he has to use only his own capital.

The profit margin will increase too when the business goes in his favor and vice-versa.

Similarly, leveraging in crypto currencies implies the use of borrowed funds to engage in crypto currency trades.

The use of leverage by crypto currency traders increases their exposure in the market, making it possible to have some good profits

For example, a trader have only $10 as balance in his exchange wallet. But he wants to take a trade above the amount he has in his wallet. He will now borrow some assets called leverage, which gives him the ability to invest more in the trade.

So even when a traders capital is small, he can use it as a collateral for leverage trading.

However, it will be good to note that while leveraging ensures the probability of higher profits, there are high risks involved. He also has the probability of higher losses.

The higher the leverage used, the higher the profit and the higher the losses the trader is exposed to.

Explain how leverage works.

Like I briefly mentioned in the first question, for a trader to be able to use the leverage services, he must have a capital in his trading account. That capital can be looked at as a collateral. Thus the leverage he uses is dependent on having funds in his trading account.

Leverage in trade is explained as ratios. For example a ratio of 1:10 is referred to as (10x), 1:100 as 100x., etc.

So assuming a trader who has the balance of $10 in his account takes a leverage of 10x that is 1:10 to open a buy position, that means that he is opening a trade with $100 Instead of the $10 dollars he has in his exchange wallet account. This gives him increased exposure in the market.

Leverage is also referred to as margin in some exchanges. So there is need for the trader to be aware of the margin limit during the trade. When the market moves against the traders direction, he will be notified through a margin call to add funds to his trading account if not his position will be liquidated or force closed.

This means that every loss on the trade is being taken directly from his capital in the exchange wallet. So once the loss is close to the capital in his account, he will be notified that his own capital deposited is about to finish, hence the need to add funds to his exchange wallet. If that is not done, his trading position will be closed and his own collateral or deposit will be taken for the losses incurred.

To my illustrate, a trader with $10 in his account opens a buy position with a leverage ratio of 1:10, that means he open a position of $100 for that trade.

However, before being liquidated a margin call will be given him to add funds to his trading wallet to avoid liquidation.

Why is leverage used in crypto currencies?

° To increase their profit level

Many trader takes advantage of leverage to increase the size of their position in a particular market. This offers them the opportunity of making huge profits as well as huge losses too.

° increased market exposure

It assist traders to open multiple positions with less capital , taking advantage of any small price movement to make profit.

° Portfolio Diversification

It offers traders the opportunity to diversify their portfolio and investment decisions.

° Shorter trading period with much profits

it provides the trader the opportunity to make profits faster, within the shortest amount of time possible.

If you want to open a long position and you have 12,000 USDT in Steem and a leverage of 10x. Explain if the price of Steem rises by 45% and then explain if the price drops by 15%. Give your own opinion.

I want to open a long and short position with 12,000 USDT in Steem (0.25/steem ($12000 ÷ 0.25 = 48000 steem)) using 10x leverage.

This implies that the actual value of my position will be

*12000 x 10 = 120,000 Usdt (48000 × 10 = 480000 steem). This means that I will be entering the long and short position with 120,000 USDT (480000 steem).

Long position

Long position opened with 12000 usdt (48000steem) with 10x leverage amounting to 120000 USDT (480000 steem). It rises and made a 45% profit, the profit in USDT (steem) will be :

45% (0.45) of 120000USDT (0.45 of 480000 steem) = 54000 USDT (216000 steem).

Remember that I have a total amount of 12000 USDT (48000 steem) as my capital. If the transaction is closed at that 45% increase in price, the total will be a gross profit of 54000 (216000). Remember that trading fee have not be taken into account.

Where the trading fee which is usually 10% is removed, the balance in the account will be

Trading fee= 10% of leverage amount (10×)

Trading fee= 0.1 × 12000 = 1200

This amount is added to the initial amount to have 13200 USDT (1200 + 12000) which forms my new gross capital that is assumed that i am trading with.

Therefore, the net profit will then be

Net profit = gross profit - gross capital - trading fee

= 54000 - 13200 -1200 = 39600.

Therefore, net profit = 39600 USDT

The profit made with the help of the leverage is 39600 USDT within the shorted possible time as against 5400 USDT which i could have made with just my capital and within the same time. And the difference which is 34200 USDT is much and mouth watering, anyone would want to take advantage of this leverage after due calculation.

Short position

In the same way with a leveraged position of when there is a 15% drop in price on a 12000 USDT account with 10% leverage, gross loss will be 18,000USDT (0.15 × 120000).
18000 USDT represents the gross loss

Incorporating the trading fee which is charged irrespective of whether a profit is made or loss, we will arrive at the net loss. This;

Trading fee has been determined already as 1200 USDT above.

Adding it to the initial amount to give 13200 USDT.

Therefore, net loss will be

Net loss = gross loss + gross total

= 18000 + 13200 - 1200= 31200 USDT

Take note that the trading fee is not subtracted again because it is a loss and not profit

Therefore, i made a loss of 31200 USDT as again 1800 USDT if i had traded just with my capital of 12000 USDT and the difference is 29400 USDT. This is huge loss.

I will like to compare my profit level with the leverage against my loss level with the leverage to know if it is worthwhile.

Profit of 39600 and a loss of 31200 USDT

39600 - 31200 = 8400 USDT.

From the comparison above, the leverage is not worth it. A high risk opportunity should be able to cover losses upto 2 or 3 times at a trade such that when loss occur, i will be able to bear it and know that i would have made more if it were profit and i will strive to go for it again knowing that if i am able to hit the jackpot, it will cover every losses.

In my opinion, it is good to trade with the capital of 12000 USDT (48000 steem). The risk of taking advantage of leverage is not worth it unless if the capital is too low that one is left without options.

The only gain here is the possible exposure to different investment or trading opportunities to make profit which one with low capital may not be able to have.

Mention the advantages and disadvantages of leverage.

Advantages

° Increase in Profitability

leverage are used by traders to increase their profitability when taking trades. A trade taken with only $20 may give $3 profits, but when leveraged, can give as much as $15 within the same time frame.

• It offers selling opportunity.

Leveraging offers a trader the opportunity to short sell and benefit from drop in price of an asset in the market. Thus making more money in the process.

° Trading multiple positions.

With leveraging, a trader can open many positions in the market with just a little capital in his trading account. This enables them to diversify his portfolio and investment risk.

° Hedging

This is trading method used by advanced traders to minimize their loss when the market is not favorable to them. Assuming the trader was on long and suddenly the market starts to sell. The trader can open a short position and rake in some profit while the long is still on. This helps him to reduce his losses. This can only happen under leveraged positions.

Disadvantages

° Increased transaction fees.

Use of leverages leads to increased cost of trading fees. What will be charged as trading fees in a leveraged positions is usually higher than in a spot position. So the trader pays more whether in profit or loss.

° Possibility of huge losses

Due to use of leverages, the possibility of high losses is very huge. Just as leverage increases profitability level, likewise it increases the level of losses too.

° Increased Volatility in the market.

Since many positions can be opened with low capital due to leverage, the rate of liquidity increases which leads to higher volatility in the market.

° Increased possibility of Account Liquidation.

There is high possibility of losing everything you have in your trading wallet due to liquidation. The chances are very high compared to spot trade

Conclusion

Crypto currency leverage trade gives a sweet and sour experience depending on how experienced a trader is and his ability to manage his risk.

Happy reading and learning to everyone!

Cc: @sahmie was the one that invited me to take part.