Leverage & Initial/Maintenance Margin
Leverage, Initial & Maintenance Margin fundamentals
Last updated
Leverage, Initial & Maintenance Margin fundamentals
Last updated
Leverage, a fundamental concept in finance, refers to the practice of using borrowed capital to amplify a position size. This financial tool enables market participants to control larger positions than their initial investment would allow, magnifying the outcome of their trades. Utilizing leverage is prevalent across various financial instruments, including crypto.
The primary advantage of leveraging lies in its capacity to enhance potential returns. With a relatively small initial investment, traders can achieve considerable market exposure, which can lead to substantial profits if the investment's value increases. In this sense, leveraging allows investors to maximize their returns on successful trades without committing additional capital.
Kwenta currently allows for 25x leverage, allowing someone with 100$ in initial margin to open a trade worth $2,500.
Note that leverage is a double-edged sword!
While it magnifies profits, it also increases the risk of losses. The higher the leverage, the greater the risk. If the market moves against a leveraged position, traders may experience total losses of their initial collateral, leading to liquidation. This makes prudent risk management essential when using leverage.
Traders employing leverage should carefully assess their risk tolerance and use strategies to mitigate potential losses. These strategies include:
Stop-Loss Orders: Automatically close positions if the asset's price reaches a predetermined level, limiting losses.
Position Sizing: Adjust the size of trades based on risk tolerance and the characteristics of the asset.
While leverage presents opportunities for enhanced returns, it also carries the potential for significant losses, making it imperative for traders to approach this financial tool with caution and employ effective risk management strategies.
The initial margin is the minimum amount of collateral required to open a leveraged position. This serves as a safety buffer to ensure that traders can meet their obligations and cover potential losses.
How It Works
The initial margin is calculated as a percentage of the total value of the position. The percentage depends on the leverage selected by the trader. For example:
To open a $100,000 position with 20x leverage, a trader would need to deposit $5,000 as collateral (5% of the position value).
The maintenance margin is the minimum account balance required to keep a leveraged position open. If the account balance falls below this level, the position becomes at risk of liquidation.
How It Works
The maintenance margin is typically lower than the initial margin, allowing for market fluctuations. It is also calculated as a percentage of the position's total value. For example:
If the maintenance margin is 1.5% (150 basis points) on a $100,000 position with $5,000 in initial margin, the trader must maintain at least $1,500 in their account to avoid liquidation.
If the account balance falls below this threshold, the trader may receive a margin call, requiring them to deposit additional funds or reduce their position size to meet the margin requirement.
