Lesson 5 of 6 · 8 min

Leverage and Liquidation

Leverage lets you open a position larger than the money you put up as margin. With margin of 500 and leverage of 10, the position is 5,000. Profit and loss are calculated on 5,000. The rest is borrowed, and the exchange protects itself by forcibly closing the position before you lose more than your margin. This is called liquidation.

How close is liquidation

Roughly, liquidation is about 1 / leverage away from entry. In reality it is slightly closer, because the exchange also requires a maintenance margin, and the rules differ between exchanges.

• Leverage 2: a move of about 50%.
• Leverage 5: a move of about 20%.
• Leverage 10: a move of about 10%.
• Leverage 20: a move of about 5%.
• Leverage 50: a move of about 2%.
• Leverage 100: a move of about 1%.

In the crypto market a daily move of a few percent is nothing unusual. With leverage of 50, ordinary noise is enough to wipe out a position, even if the idea itself was right.

Leverage is not the same as risk

This is the most important idea of the lesson. Risk is determined by position size and stop, not by leverage.

The safety check is simple: the stop must be much closer than liquidation. With leverage of 20 liquidation is about 5%, so a 5% stop makes no sense. With leverage of 5 liquidation is about 20%, and a 3% stop has plenty of room. If an order only goes through with leverage that puts liquidation near your stop, the position is too big for your account.

What else comes with leverage

• Funding fee. On perpetual futures it is paid periodically between buyers and sellers, so holding for a long time can be costly. The amount and interval depend on the exchange. Hypothetically, 0.01% per period on 100,000 is 10 each time.
• Isolated and cross margin. With isolated margin, the deposit is limited to the position. With cross margin, the whole account can serve as margin, which means a loss on one position can drag everything down.
• Liquidation cascades. In sudden drops, forced closures push the price further and trigger new liquidations. Your stop can fill much worse at such a moment.
• Short selling. Leverage and derivatives allow you to profit from a fall, but the price can theoretically rise without limit, so the loss on such a position is capped only by a stop or by liquidation.

The portal's Demo has no leverage and no short selling, deliberately. A position cannot be larger than your free funds. Until you keep a positive journal across many spot orders, leverage doesn't give you an edge, it only speeds up your mistakes.

In the lab, change the leverage and watch the drop to liquidation, as well as on how many of the last 365 days BTC fell by that much within the day, measured from the open to the low of the day. The calculation is approximate, with an assumed maintenance of 0.5%. Find the leverage at which such days stop being rare. For comparison, you can find the hourly ATR in Analysis.

You can try leverage without real risk on the Demo's futures. A position there is liquidated at the real mark price, and the real funding rate is charged. Open a small isolated position, look at the estimated liquidation price and compare it with the distance to your stop.