🔴🔴 ATTENTION TRADERS 🔴🔴
If you’re involved in Futures trading, this is an important read for you.
🔴 LEVERAGE: A POTENTIAL DISASTER IN THE MARKET
I’ve reiterated numerous times, “Avoid futures and leverage if you’re new to crypto. Even with 3-4 years of experience, it’s advisable to refrain.” However, the focus here is not on this advice, but rather on explaining the impact of leverage on the movements in the crypto market.
🔴 UNDERSTANDING LEVERAGE
Let’s first understand how leverage works. Suppose you open a trade to buy with $500 using 10X leverage. This will act as if you had $5000 in your account. How does this work? The exchanges (in this case, Binance) will lend you $4500. In exchange, if the price drops by 10% (your $5000 turns into $4500), your position is automatically closed to prevent you from owing the exchange. This is known as being “liquidated”.
When you get liquidated in a long position, it instantly creates a market sell-off at the moment of your liquidation. This means that your remaining $4500 is sold so that Binance can recover its money.
🔴 LEVERAGE ON A LARGER SCALE
Now, let’s apply this phenomenon on a much larger scale. Imagine that 100,000 traders enter long with 10X leverage on ETH at three different levels: at $2.8K, $3K, and $3.2K. If the price drops to $2.7K, a -10% from $3K, the traders who entered will get liquidated. This triggers massive sell orders in the market, which can significantly push down the price of ETH. It could further drop to $2.5K due to massive liquidations, triggering the liquidations of those who entered at $2.8K, and so on. This is known as cascading liquidations.
🔴 RISK OF FLASH CRASHES
When too many people open positions with leverage, it creates a risk of very strong and rapid liquidations. This can lead to “FLASH CRASHES”, moments of a few minutes where ETH can drop 15-20%. This works the same in traditional finance, on the scale of banks/hedge funds, and so on.🔴🔴
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