💪Leverage & Initial/Maintenance Margin

Leverage, Initial & Maintenance Margin fundamentals

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 can amplify potential profits, it also magnifies potential losses. As the level of leverage increases, so does the degree of risk, which means that traders employing leverage may experience total losses of their initial investment, also known as liquidation.

Prudent use of leverage necessitates effective risk management. Traders should carefully assess their risk tolerance and employ strategies to mitigate potential losses. These strategies may include setting stop-loss orders, which automatically close a position if the asset's price reaches a predetermined level, or position sizing, which involves adjusting the size of a trade based on the investor's risk tolerance and the specific characteristics of the investment.

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.

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Initial margin Refers to the minimum amount of collateral that traders must deposit with their exchange to open a leveraged position. This deposit serves as a safety buffer, ensuring that traders can meet their obligations.

Calculation: The initial margin is typically calculated as a percentage of the total value of the position. This percentage varies depending on the traders selected leverage.

If a trader wants to open a $100,000 position with a 20x leverage modifier, they would need to deposit $5,000 as collateral.

Maintenance Margin The maintenance margin is the minimum amount of equity that traders must maintain in their account to keep their leveraged positions open. If the account balance falls below the maintenance margin, traders may face a margin call, requiring them to either deposit additional funds or close some or all of their positions to meet the margin requirements.

Calculation Similar to the initial margin, the maintenance margin is calculated as a percentage of the total value of the position. This percentage is usually lower than the initial margin requirement, allowing for some fluctuations in the market value of the position.

For instance, if the maintenance margin is set at 150 bps or 1.5% for a $100,000 position with $5000 in initial margin, the trader must maintain an account balance of at least $1,500 to avoid a margin call.