The number of investment vehicles has grown proportional to the number of investment opportunities. Today, it is so diverse that a random combination of three letters of the alphabet is quite likely to represent an investment vehicle! However, all these investment vehicles are bound to fall under any one of the four categories: stocks, bonds, commodities, and cash.
When it comes to volatility, the leader in this quartet is commodities. Optimistically speaking, the magnitude of volatility represents the magnitude of profitability/return. Applying the same logic to the other end of the spectrum, it also represents the possibility of a considerable loss as well.
Investors have been counting on this volatility, and commodities have lived up to its reputation of being one of the most profitable and highly speculative as an asset class. One of the key factors driving the volatile nature of commodities is that most of the investors trade commodities using a futures contract. These contracts are designed in a way that they provide maximum benefits of speculation for traders who understand the market and who prefer to participate in trading in a highly volatile environment. There is no question that the risk of loss is high, but at the same time, the possibility of profit-driven by the understanding of the market trumps the risk of losses for experienced traders.
What is futures trading?
This term has been existing in the financial trading markets for quite some time now. The term is quite self-explanatory. You trade for the future at a predetermined price period. Let us simplify this for you. Futures trading simply means that you purchase a commodity at a specific cost, and you agreed to sell the commodity at a predefined price on an agreed date, irrespective of the trading price of the commodity.
It is important for the trader to observe the behavior of the price of the commodity in the market. As most of the traders would understand, the value of the commodity is bound to fluctuate highly because of its extreme volatility. Therefore, the trader can agree to sell their commodity at a fixed price at a specific date. If the price of the commodity drops, the trader will still be able to sell their assets at a predefined price, making them better profit or at least avoid a big loss. However, if the commodity sells at a much higher price, they do not get to enjoy the benefits of the high price either. Although technically it might not be considered a loss, it is common for most investors, akin to a loss, because they could have made better profits had they stuck to spot trading.
Although the core concept remains the same, that is quite a lot of math that goes into fixing the price of future trade. It cannot be arbitrarily assigned, so the traders are completely immunized against losses in every possible way. There is, in fact, a way to trade without a loss (although it doesn't guarantee any protection against losses because of higher spot prices) when it comes to futures trading, and it involves selling the commodity before the expiry date.
The Relevance of leverage in futures trading
Futures trading happens in contracts. These contracts carry with them a bulk of the commodity, and it might not be possible to purchase a fragment of what the contract represents. Proportional to the volume, the prices of these contracts are also bound to be on the exorbitant side, making them inaccessible for individual investors and restricting the purchase of futures contracts to just the institutional investors.
To circumvent this challenge, the futures trading exchange provides the trader with an additional chunk of cash called leverage. In any exchange, the leverage is decided as a multiplier of the amount that the investor has in their exchange account. Some exchanges give a 10x leverage, while others offer up to
100x leverage.
Also, to ensure that exchanges provide leverage only to worthy investors, they set a certain threshold amount as the minimum balance requirement for the exchange for granting leverage. This minimum amount is defined as the margin.
An example
Let's say there is a futures contract worth 100 bitcoins. With the current price of the bitcoin at $7000, there is no possibility for any individual investor to possess $700,000 at their disposal. Therefore, the
Cryptocurrency exchange can provide a
margin of 100x, so the trader can execute the trade by purchasing the futures contract.
At the same time, the exchange also fixes a margin telling that no investor who has less than two bitcoins in their exchange account stands eligible for the leverage.
The trader can now enter the trade by purchasing the futures contract of 100 bitcoins by using the leverage. If the price of the bitcoin prices rise to let's say, $7100, instead of earning a profit of $100, which would have been the case if they had used their own money, the profit would now be $710,000. The trader can now return the money that they borrowed, along with a small interest. This not only helped the trader execute the futures contract trade but also maximize their profit.
In another scenario, let's say that the price of the bitcoin falls to $6900, the loss suffered would be $10,000. However, since it was mandatory for a trader to have two bitcoins, the possible losses will be recovered from this margin by the exchange. In addition, the exchange will also charge its interest rate on the borrowed amount. This combination makes
margin trading with high leverage a high-risk-yet-high-profit gamble for the investor but a sure-shot profit for the exchange!
In any case, it is quite evident that the exchange does not lose any money even if it were to provide huge leverage for traders, There are a lot of financial institutions who are willing to invest in crypto platforms for leveraging trading as it is one of the most promising crypto business avenues for the future.
Conclusion
Given these parameters, it could be a great idea for aspiring entrepreneurs to invest on margin trading
crypto exchanges with high leverage. With the availability of
white label solutions, your crypto exchange can go live in no time, and you are all set to make it profit from the trades of promising and aspiring crypto traders.
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