How To Use Leverage Correctly When Trading Crypto Derivatives

The aggregate market capitalization of cryptocurrencies is close to $2 trillion at the time of writing, and such growth in the industry would probably not have been possible without the development of the derivatives market. Since traders have the option of trading crypto derivatives without dealing with the underlying instruments at all, while also being able to use leverage, it is no wonder this market has added to the attractiveness of the whole crypto sphere.

However, margin trading comes with several risks, especially when it comes to volatile assets like crypto. In such an environment, you need to know how to use leverage professionally, making sure it works to your advantage and not the other way around.

Higher volatility – lower leverage

A good rule of thumb is to opt for lower leverages when dealing with volatile assets. During the past two weeks, Bitcoin, the largest cryptocurrency in the world, lost around 20% of its value, while smaller altcoins posted even bigger losses. Prices are moving at a fast pace, so there is no need to expose yourself to potentially high losses via leverage.

Most of the reputable retail brokerages in the industry cap the maximum leverage rate for crypto instruments at low figures, so customers will not be vulnerable when markets don’t behave as expected. Remember, leverage is a double-edged sword and its consequences can be devastating when it does not work in your favor.

Keeping risk under control

Considering leverage can either increase returns or losses, you should use risk management tools like stop loss or take profit when dealing with it. Even though you are trading on margin, a stop loss can cap the downside even if things don’t evolve as expected, thus limiting the damage, in line with your risk parameters.

Just like with other asset types, you should be risking a fixed percentage of your account on each crypto trade. It could be 2%, 3%, or 5%, depending on your risk tolerance, prior performance, strategy, and other parameters.

Allocate only a small portion of the account

Now that trading brokerages offer crypto trading on top of other popular asset classes via contracts for difference (CFDs), you have the opportunity to build a diversified portfolio without needing to use a cryptocurrency exchange. The maximum leverage is different depending on the asset type, which can ensure an optimal asset allocation mix.

Traders are influenced by large price swings they see in the crypto sphere, often mistakenly assuming this will transpire into returns. In reality, you need proper tools and techniques to take advantage of these price swings. Your bottom line could be lower, but by diversifying among assets you won’t be solely exposed to crypto price movements.

Diversify among different tokens

Lastly, even in the crypto space, there are numerous promising projects that have emerged over the years. Stellar, Litecoin, and Bitcoin Cash are just some examples of altcoins currently holding decent market capitalization.

Depending on whether the brokerage you are working with offers multiple cryptocurrencies, you can feel free to take advantage of the variety, as long as you can diversify among multiple cryptos. Digital assets are not 100% correlated, which means some might outperform while others stagnate.