Wordbook: Double-Edged Sword

Position size is the amount of notional value you want to purchase.

Required margin is the amount of capital you need to put into the exchange to purchase the cryptocurrency.

Leverage is a number you can set to multiply your position size. Therefore, the larger the number of your leverage, the larger your position size.

However, when you set your leverage higher, there is also a higher risk of losing all your required margin, called liquidation.

For example:

John wants to buy a long position for 1,000 contracts at 7000 USD. The position size is:

 

At Leverage = 3x

The required margin to open the position is 0.04 BTC and the Liquidation Price for Leverage 10x is 2,283.10 USD. The Maintenance Margin Rate for BTC is constant which is 0.5% as the exchange only offers up to 100x leverage. Once the Market Price hits Liquidation Price, the Liquidation engine will be triggered.

 

At Leverage = 100x

The required margin to open the position is 0.00143 BTC and the Liquidation Price for Leverage 100x is 6,965.17 USD.

We can see that the higher the leverage, the lower the required margin and the higher the liquidation price.

If you open at Leverage 100x, your liquidation is only 134. 83 USD from the market price which is 7,100 USD. Meanwhile, if you open at Leverage 3x, your liquidation is 1,830.24 USD from the mark price meaning you will less likely be liquidated.

To avoid being liquidated, we can add to the margin.

 

The increase in chances of liquidation as the higher your leverage goes is the reason why it is a double-edged sword.

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