Leverage allows you to place trades larger than what you have in your collateral balances.
Suppose you have a 5,000 USD balance. Using the maximum leverage of 5X, you could open up to a 25,000 USD position (long or short). If you close this position for a 20% gain at 30,000 USD, your account balance will grow by 100% (5,000 USD). This amplified upside potential is why traders find leverage exciting.
However, if the value of the position falls by 20% to 20,000 USD, your USD balance will be wiped out.
Leverage determines two things:
- Your used margin.
- Your maximum position size.
Used margin is the amount of your collateral balances that is withheld in order to open a margin position. Used margin is calculated as the position size (or "cost basis") divided by the level of leverage.
Let's say you open a 5,000 USD long position in XBT/USD.
With 5X leverage, only one-fifth of the position size, or 1,000 USD worth, will be withheld from your collateral balances. Your remaining collateral balances will be available for opening more positions.
With 2X leverage, half of the position size, or 2,500 USD worth, will be withheld from your collateral balances.
Maximum Position Size
The possibility of larger profits along with the risk of larger losses (and liquidation) is determined by the size of the position relative to your collateral balance and not merely by the level of leverage you select.
When placing a margin trade, position size is selected separately from the leverage level. Selecting 5X leverage does not mean that your position size is automatically 5X bigger. It just means that you can specify a position size up to 5X your collateral balances.
If your collateral balances are 5,000 USD and you create a margin position for 5,000 USD with 5X leverage selected, your profits and losses will be no different than if you created a non-leveraged trade for 5,000 USD.
How much leverage should be used?
However, if the position size is maximized based on the leverage selected, then a higher leverage would be more risky.
Before using leverage, please take time to fully understand it and the risks involved. There are a lot of concepts to learn, but this is your money at stake, so it's worth your time to walk through everything carefully.
Large positions created using leverage can quickly amplify your losses and even wipe out your account if you aren't careful.
Opening a leveraged position should be considered a short-term trade, not a long-term investment.
Sensible risk management should be employed when trading with leverage: you should set both a stop loss and a profit target for every open position.