About leverage
Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.
- Archimedes
This will be a short article. I don’t have much to say about the topic but I am tired of seeing people the same mistake about leverage over and over, and most sources that explain it very well are, well, probably too hard for the average degen ape to process.
Leverage as a tool, expecially in crypto, is regarded by far too many as this dangerous and lethal weapon that only few can handle, and with good reason, but also for some very flawed reasonings that unfortunately form the majority view on it.
What leverage is, to give a simple definition? Leverage is the ability to borrow money - usually from the same exchange you trade on - to enter a trade. Nothing comes for free, least of all money, so exchanges charge you a cost for it, and needs to protect itself in case you’re a [redacted] and are about to lose your trade gamble. That is, they liquidate you and charge you a liquidation cost on top of it. Liquidate means that they forcibly close your trade, and keep whatever capital/margin is left to repay the cost. This happens at a liquidation price which is calculated based on size of margin and capital borrowed.
This definition seems to find everyone pretty much agreeing, what goes wrong after this is the interpretation of what leverage is used for, or should be used for, or why it should be avoided.
You see, people, especially new participants with - too - small capital, think that leverage is a way to multiply the money they can trade with:
“ah! I have only $500, but if I do 10x leverage I can trade with $5000 so I can make the same money in my trade as a guy who is 10x richer!”
And then they get rekt. And start thinking leverage is a tool of the devil, and people should stay away etc. and it spreads like that.
Instead, leverage should be a tool to minimize the use of needed capital that you own, to enter a trade. It is not a tool to amplify or multiply risk, it should be used a tool to minimize it!
An example: say you have $100,000 of capital, let’s call it margin. You want to enter a trade, but risk maximum 2% of your money = $2,000. Now, you looked at your chart, you found your entry - one, for simplicity - your take profit level(s), and you can see on the chart where your invalidation would be. Now, what you do is for example calculate by hand or with tools like tradingview offers, your positioning, and voilà, you have your sizing, and you know you’re willing to risk 2k so everything else follow.
Now you are ready to choose the leverage needed in order to employ only the margin amount you need for the trade! For example you put those $2,000 of margin, and use leverage to reach the size desired, and know that if you get liquidated, you lost only those $2,000 that you were ready to begin with!
It is not a tool to scale up, it is a tool to scale down!
Now the smarter among you may be wondering: “but Heart, if you have 100k, and you enter with your own money and get out at 2k loss, isn’t it the same?”
Well guess what, it pretty much is! What is different here is that for example you could want to have more than one trade going, and the sum of positions could be larger than your total margin, so leverage could help you to go a little bigger but for example still say you’re 1.2x exposed, it’s not being [redacted] like those guys scaling it to 20-50x and blowing it up!
The bottom line here is that if you don’t have much capital to begin with, you’re not gonna magically borrow it from the market and trade your way to millions, except a few genius exceptions (GCR, etc.). You should start trading only with a decent base to begin with - say, $10,000 - and practice all the risk management good practices. Crypto is already as it is a speed-lane to riches, to try and cheat the line for faster results will only lead to your ruin, unless you’re exceptionally talented
(spoiler: you’re not!)
Hope this helped clearing ideas to some people.