Over the years I've seen a lot of investors but also people in the community talk about leverage. While most already stay far away from it ( based on a bad experience or simply out of risk management reasons ) there are plenty of people that like to enter high leveraged positions.

The dangerous part however is, that many don't really fully understand the market they are entering and the professional tools they are using. With this post I want to simplify summarize the most important things about futures trading that many seem to not be aware of.

High leverage ≠ free money

https://preview.redd.it/arpu07k2dfqb1.png?566&format=png&auto=webp&s=70b063d13cb2ce7150c4039673764a0e9da96e8f

I think most have seen a window like this before when opening the "futures" tab or "trading" tab on any exchange. You can see the leverage silder and the option to open a long or short position.Some exchanges even offer as much as 200x leverage. While some see this as "free money to gamble" there's actually huge fees many aren't aware of.

Maker & taker fees

https://preview.redd.it/8lxcnedkdfqb1.png?948&format=png&auto=webp&s=a7e641422597a2c52cb84ad8f0e37b6d5d3d1cd1

Above you can see a list of the applied fees to your trades based on your 30-Day Volume from Kraken.The average retail investor will most likely count into the first group so let's use that bracket for this example.

An example:

Josh, the fictional created trader for this scenario, is very bullish on Ethereum and believes it will go up in value in near future.Josh therefore opens a position using 100x leverage because he wants to make as much money as possible. Josh uses 500 USDT as margin therefore opens a 50,000 USDT value position.

Josh thinks as long as the price stays around his entry or above, he is in profit.

Here's the reality:

Opening the trade using a market order + closing the trade will be 0.07% fees * leverage.In other words, Josh position basically starts with a -7% PNL due fees. So even if he closes it perfectly at break even, he still lost 7% -> -35 USDT.

Funding fee

But Josh got very lucky! And the price of Ethereum stays around the value of his entry point. After 3 Days Josh is still looking at the same 0% unrealized profit/losses because the price hasn't moved at all.

However, on top of the realized losses due fees, there's even more losses coming from something called funding fee.

https://preview.redd.it/3dyd0zfeffqb1.png?2501&format=png&auto=webp&s=7b1c7d0996b9972bdbd3236d2610d8fd6f61ec3d

Summarized, funding fees will be exchanged between long & short position holders every 8 hours. If the funding rate is positive, long position holders will pay short position holders. If negative, the opposite happens.

Funding Fees = Position Value * Funding Rate

Therefore Josh just got shocked with an even higher realized PNL on his position! Every 8h in the 3 Days, he paid a 0.015% fee. That means 9 * 0.015% = 0.135% * 100x Leverage = 1.5%

So Josh took another loss of -7,5 USDT on top of the -35 USDT although nothing has happened in the market.

Josh is now down almost 10% for simply entering a high leverage trade because he diddn't know what all the extra fees are and how they interact with leverage.

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Margin Ratio

And on top of all this, there's a way worse downside of using high leverage called "margin ratio".A 100x leveraged position means every 1% increase of the asset will result into a +100% value.However, the same counts for the downside. A -1% drop will make the entire position completely worthless.

However, due volatility, an exchange usually closes the position slightly above the liquidation level for fairness reasons that are quite complex. But simplified, they won't let your position reach a lower liquidation point than it should therefore on high volatility & illiquid orderbook will liquidate it above the liquidation level than letting it go below it.

Summarized, the position, that already took a ~-10% hit because of fees, already has a higher liquidation level than initially expected can also close even earlier than reaching that point due margin ratio of an exchange.

In other words, a -0.75% drop could potentially trigger a full liquidation and cause an entire -500 USDT loss.

Conclusion and personal thoughts

Leverage trading is a professional tool for traders and investors to diversify their positions, open hedges against their holdings and profit out of accurate short term predictions. However, with professional tools comes also complexity and difficulties that many don't understand.

It is ridiclous that any person owning crypto can use up to 200x leverage without any problems on many exchanges. There are no serious warnings, no explanation about fees and no restriction for inexperienced users.

I do not recommend anyone touching futures and high leverage without being fully aware of everything that is involved. This post includes basic information about unknown costs however there's way more about this topic especially when it comes to liqudiity, type of orders and risk management. If you are still interested, there's plenty of sources to learn a lot and there's nothing wrong starting with very small amounts and analyzing every number just to get a feeling for it.

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Hope you enjoy the read - stay safe and don't gift the market maker free money