4.1 Leverage Trading
Leverage trading represents a financial tactic enabling traders and investors to command larger positions in financial assets than their original capital would allow. This strategy entails borrowing funds, from the Swych PDEX, to increase the scale of their trading ventures. Leverage trading is adaptable across various financial markets, including cryptocurrencies. In the realm of Decentralized Finance (DeFi), leveraging emerges as a novel and pioneering approach to trading and investment. DeFi harnesses blockchain technology and smart contracts, empowering users to trade and borrow assets in a decentralized manner, without reliance on traditional financial intermediaries such as banks or brokers.
Leverage trading within a Perpetual Decentralized Exchange (PDEX) encompasses a trading method that empowers traders to magnify their potential profits (and losses) by employing leverage on the assets they handle. It is crucial to acknowledge that leverage trading involves heightened risk compared to traditional spot trading, as it amplifies both prospective gains and losses. On a PDEX platform like Swych, leverage trading predominantly transpires through decentralized perpetual positions.
Here's a detailed explanation of how leverage trading works on a DEX:
Understanding Leverage: Leverage essentially means borrowing funds to increase the size of your trading position. In the context of decentralized exchanges, leverage is expressed as a ratio (e.g., 2x, 5x, 10x), representing how much you can multiply your trading position size compared to your initial capital. For example, if you have $1,000 in capital and use 5x leverage, you can control a trading position worth $5,000.
Magnified Gains and Losses: The primary appeal of leverage is the potential for amplified gains. When the market moves in your favor, the profits on your leveraged position will be magnified compared to what you'd earn with your initial capital alone. However, it's crucial to understand that losses are also magnified in the same way. If the market moves against your position, losses can accrue rapidly.
Borrowing and Trading: In leveraged trading, you use a portion of your capital as collateral to borrow additional funds for trading. The collateral is essentially a security deposit to cover any potential losses. The borrowed funds are referred to as "margin." The total value or position size of your leveraged position is the sum of your collateral and the borrowed margin.
Managing Risk: Leverage trading involves significant risk. If the market moves against your position, you can incur losses faster than in spot trading. To mitigate risk, PDEXs often implement a mechanism called "liquidation." If your collateral's value falls below a certain threshold (the liquidation price), your position may be automatically liquidated to cover the borrowed funds and protect the lender. The more leverage used on a position, the closer the liquidation price is to the entry price.
Liquidation: When you open a leveraged position, the PDEX sets a "liquidation price." If the market moves against your position and the value of your collateral falls too close to this price, you may receive a "margin call." This means you'll be required to add more collateral to maintain your position or risk liquidation. Liquidation involves the PDEX selling your position to cover the borrowed funds and protect the protocol, often resulting in a significant loss for the trader. It is important to note that the higher the leverage used, the tighter the spread is between the entry price and the liquidation price. Always take this spread into consideration, along with market volatility, when using leverage.
Closing Positions: You can close your leveraged position at any time, either to take profits or cut losses. Closing the position repays the borrowed funds and releases any remaining collateral back to your wallet.
Education and Practice: Before engaging in leverage trading on Swych, it's crucial to educate yourself thoroughly. Practice on the Swych PDEX Paper Trading Platform, or with a small amount of capital on the live Swych PDEX, to gain experience without risking significant losses.
In the visuals provided below, you can observe the impact of employing leverage. In the initial illustration, 1 ETH is employed as collateral, leveraging it by a factor of 10x. As a result, the position size expands to nearly 10 ETH. In the subsequent illustration, 1 ETH is once more employed as collateral, but this time with a 20x leverage, leading to an enlarged position size of almost 20 ETH.
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