Bitcoin Leverage & Margin Trading Explanation and Example
Definition of Trading Terms:
Margin required: This is the amount of money your broker requires from you to open a position. It is expressed in percentages.
Equity: This is the total amount of capital you have in your Bitcoin trading account.
Used margin: The amount of money in your account which has already been used up when buying a Bitcoin contract, this Bitcoin contract is the trade transaction that is displayed in open trades. As a trader you cannot use this amount of money after opening a trade with it because you have already used it and it is not available to you - until after when you close your open position.
In other words, because your broker has opened up a position for you using the capital that you have borrowed, you must maintain this used margin for trading as a security to allow you to continue holding the open trade that you have opened using this leverage that the broker has given you.
Free margin: The amount of money in your account that you can use to open new trade positions. This is the amount of money in your account which has not yet been leveraged because you've not yet opened a transaction with this money - this margin is also very important for you as a trader or investor because it enables you to continue holding your open trades as will be explained below.
However, if you over use leverage, this free margin will drop below a certain percent at which your broker will have to close all your positions automatically, leaving you with a big loss. The broker at this point closes all your open positions because if your positions are left open the broker would lose the money you have borrowed from them.
This is why you should always make sure you've a lot of free margin. To do this never trade more than 5:1 leverage in fact 2:1 leverage is recommended when trading Bitcoin Cryptocurrency.
Difference between Leverage Set by the Broker and Used Leverage
If the set leverage is 5:1, it means you can borrow up to 5 dollars for every dollar you have but you do not have to borrow all the 5 dollars for every dollar you have you can decide to borrow 4:1 or 2:1. In this case even though the leverage option set 15:1 your used leverage will be the 4:1 or 2:1 that you have borrowed to make a trade transaction.
Example:
You have 10,000 dollars (Equity)
Leverage set 5:1
Leverage Used = Amount used /Equity
1 Contract - $5,000
If you buy 10 standard lots which is equal to 50,000 dollars you will have used
= 50,000/10,000
= 5:1
5 Contracts
If you buy 5 lots which is equal to 25,000 dollars you will have used
= 25,000/10,000
= 2.5:1
2 Contracts
If you buy 2 lots which is equal to 10,000 dollars you will have used
= 10,000/10,000
= 1:1
Meaning you will not be using any leverage & you will only be trading using the amount you have deposited.
In these three cases you can see that even though the set leverage is 5:1 - The used leverage is 5:1, 2.5:1 and 1:1 depending on the size of lots traded.
So Why not just Choose 5:1 option as the Maximum Leverage? Because to keep within the proper risk management rules it is even recommended that investors use less than this leverage?
This question might seem straight forward but it's not, because when you trade you use borrowed money known A.K.A. Leverage. When you borrow capital from anyone or a bank you must maintain a security or collateral to acquire a loan, even if the security is based on monthly deduction from your salary, the same thing with Bitcoin Trading and Online Trading.
In online trading the security is known as margin - your deposit. This is capital you deposit with your broker.
This margin is calculated in real time as you trade. To keep your borrowed money you must maintain what is known as the required capital (your deposit). Now if Your Leverage is 5:1
When trading - if you have $10,000 and use leverage option 5:1 and buy 10 standard lots for $50,000 your margin on this transaction is the $10,000 dollars in your trading account, this is the money that you will lose if your open transaction goes against you the other $40,000 that is borrowed from your broker, they will close the open trades transactions automatically once your $10,000 has been taken by the market.
But this is if your broker has set 0% Margin Call Requirement before closing your trades automatically.
For 20% Margin Call requirement before closing your trades automatically, then your trade transactions will be closed once your balance gets to $2,000 for 50% Margin Call requirement of this level before closing your trades automatically, then your trade transactions will be closed once your balance gets to $5,000.
Most brokers set their margin call level at 20% are the best because the likely hood them closing out your trade is reduced as displayed in examples above.
To know about the margin level that you will have used - these are calculated by your trading platform automatically - the MetaTrader 5 Platform will display this as "Margin Level", this will be displayed as a percentage - the higher the percentage of your Margin the less likely your trades are to get closed.
If Bitcoin price is $5,000
Example of Margin level calculation
Trading 10 bitcoin Lots
Using leverage 5:1
If leverage is 5:1 and you transact 10 Bitcoin Lots equal to $50,000
$50,000 dollars (10 lots) divide by 5:1: your used capital is $10,000
Calculation:
= Capital Used * Percentage (100)
= $50,000/$10,000 * Percentage (100)
Margin Level = 500 %
Investor has 480% margin level above the required amount (because margin call level is 20%)
Trading 4 Bitcoin Lots
If leverage is 2:1 and you transact 4 Bitcoin contracts, equal to $20,000
$20,000 dollars (4 lots) divide by 2:1: your used capital is $10,000
Calculation:
= Capital Used * Percentage (100)
= $20,000/$10,000 * Percentage (100)
Margin Level = 200 %
Investor has 180% margin level above the required amount (because margin call level is 20%)
Because when a trader has a uses higher leverage - it means that they have more margin level percentage above what is required (A.K.A. More "Free Margin") their open Bitcoin trade transactions are less likely to get closed by a margin call as explained above. This is the reason why investors will choose the leverage option 5:1 for their Bitcoin trading account and according to their risk management rules, they will not trade above 5:1.
These Margin levels explained above are shown on the MetaTrader 5 platform and traders can find these levels as shown below the Bitcoin trading charts panel on the MetaTrader 5 trades transaction window while trading Bitcoin with this MT5 platform.
