Stress In Trading: Spot vs Leverage Trading
What makes leveraged trading stressful? How to manage stress while trading using leverage? Should you avoid using leverage?
Remember the simple rule: If you can’t sleep with your position open, you’re doing something wrong.
Some of you may be disregarding the element of stress in trading and investing, but I would warn against it. Stress is the number one killer, and when it comes to trading, stress will usually make you trade in the worst possible way.
I’m no stranger to stress
I burned out from stress, and it nearly killed me. I wrote about it here. In my recovery phase, there was only one rule - no stress allowed. “How can you be a Cryptocurrency trader when you can’t handle stress?” you might wonder. I learned to manage stress very well and, for the most part, eliminate it.
After all, stress is never about what is happening on the outside. It’s always a derivative of your mind. It’s not about the situation but how you perceive it.
I’ve refocused on trading again this year, as the markets are alive and full of opportunities. With this exposure to the market, I’ve started experiencing some elements of stress. In today’s article, I wanted to highlight the enormous difference between how stressful leveraged trading feels compared to spot trading.
First, a definition for those unfamiliar with the terms:
Spot trading in the cryptocurrency markets is the buying and selling of digital assets at the current price. In simpler terms, you buy actual Bitcoin, for example. It is yours and you can do with it whatever you want.
Leveraged trading involves buying or selling digital assets with borrowed funds or margin, amplifying potential profits or losses based on the amount leveraged. In short, you’re mostly trading futures, perpetual or otherwise, or borrowing money from the exchanges to open larger positions than the margin amount in your trading account. You don’t own those assets.
If you’re a new trader or a casual investor, stay far away from leverage. It is very unforgiving, and you really need to know how to use it wisely. Otherwise, you will inevitably lose everything.
Here are the different stress levels in trading cryptocurrencies, based on the activity alone:
The least stressful: DCA(dollar cost averaging) into Bitcoin or similar large, “safer” tokens. You buy a small amount in regular intervals regardless of the price indefinitely.
Enter volatility: Investing your money in Bitcoin will entail seeing your portfolio swing up and down violently. There will be multiples up, but then up to 80% drawdowns for months at a time. It’s not for the weak-handed.
The lower the market capitalization, the larger the volatility: In short, the lower down the scale of available cryptocurrencies you go, the more volatile they are. In both directions, the “big caps,” like Ethereum, are much less volatile than some small, new coins. Seeing those tokens go down 98% is nothing rare. Could you handle that? Should you? You’re a millionaire one day, and a few months later, you lose everything. A tale as old as time in the markets.
The risk of ruin - losing everything in your account (your whole portfolio): Smaller, newer cryptocurrencies have enormous odds of becoming worthless one day. The simple fact is that 99.99% of all cryptocurrencies will one day become worthless, be delisted from exchanges, and have no buyers. Take this literally and seriously! I still have tens of thousands of these little worthless tokens I can’t sell for pennies on the dollar, as there aren’t even markets for them anymore.
Liquidation risk: The big bad wolf of leveraged trading. When you borrow money for trading or investing, the lender will want to protect their capital. They do it by liquidating your whole position or account (isolated vs. cross-leverage) when the price moves into dangerous territory. They close your position and take all your money. If Bitcoin falls a fairly standard 50%, you will be wiped out on most leveraged trades. Leverage of 3x will liquidate your position if the price drops by 30%, give or take. How long can you survive trading without a 30% wipeout in Bitcoin?
Before we go on a reminder, always manage risk on your account and every single trade! You can’t make money if you lose all your money friends. Never let that happen. Protect your capital at all costs. LINK
Why is leveraged trading more stressful than spot trading?
There are generally three reasons causing stress in leveraged trading:
You risk being liquidated, thereby losing everything, on volatility and price swings. You cannot just weather the storm and wait out a downturn in price. The lender—the exchange—won’t let that happen, and it will forcibly close all your positions to protect its money.
It increases volatility as it amplifies the price movements regarding your capital. A 5% move against you is nothing in spot, but if you lose leverage of 10x, for example, you’re down 50%!
Leverage enables you to trade with money you don’t have - up to 100 times the money, and that is a honeypot for most of us in allowing our greed to cloud our judgment.
Here’s a simple scenario—a typical bull market correction of 30%.
In scenario A, you buy 100,000 USD of actual Bitcoin with your capital. If the price swings 30%, you’re temporarily down 30% (on paper), but you can wait until the trend turns to get out of your position or even make money if the price eventually goes higher. No one can take your Bitcoin away from you. You can lose money if you sell when the price is lower than your entry, but you don’t have to!
In scenario B, you buy 100,000 USD of Bitcoin perpetual contracts or futures on leverage, using only 10,000 USD of collateral, which we call margin. You insured your position with your margin and borrowed 100,000 USD (I’m simplifying things). If the price of Bitcoin corrects for the same 30%, you lose your position as the exchange or borrower will have sold it all and take everything. In fact, it will have sold it all on less than 10% of a correction in price, as you are using a 10x leverage.
In scenario A, seeing your portfolio swing down 30% is painful to watch, but you can wait for the correction to end and sell either for breakeven or profit at some point. I’m by no means advocating you allow this to happen, as 30% can quickly turn to 60% and so forth.
I must warn you, though, that there is no rule that the price must ever come back to your initial buy! Most cryptocurrencies never see their previous ATH (all-time highs) again.
In Bitcoin, the odds of profiting from a bull market after a correction are fairly high, but even with the safest cryptocurrency, it can take years before the price returns to where you bought it! Check the historical charts if you don’t believe me. There are years of immensely painful price action between all-time highs!
If you’re trading on leverage, your odds of surviving a 30% price drawdown are almost nonexistent unless you stick to minuscule leverage, which virtually no one does.
In reality, you should only ever trade with leverage:
If you’re comfortable and disciplined with strict risk management. You need to be able to cut your losses while they’re small when borrowing money for trading!
If you use it as insurance against third-party risk, and you will actively manage that position by hedging, adding to your margin, or using stop losses when the threat of a significant drawdown becomes obvious.
I have an email inbox full of liquidation notices proving I’ve paid the price of these lessons. It’s one thing to know the theory, friends, but another to stick to your rules once your emotions take over!
The stress in leveraged trading is amplified because you will see larger percentage-wise swings in your portfolio and because you always risk liquidation on a surprise swing of the price against you.
Protect yourself against the market and yourself when treading with leverage
I protect myself from myself and third-party risk by only having about 10% of my whole portfolio on leveraged trading exchanges.
This means that even if the whole market collapses overnight or if the exchange goes bankrupt (FTX, anyone?), I stand to lose a maximum of about 10% of my portfolio. While the experience isn’t fun (I’ve been there more times than I would like to admit), it’s manageable.
I know myself enough to know that there are times when I’m like a deer stuck staring at the headlight of an oncoming truck! While I’m generally incredibly risk averse, even I fall victim to greed and find myself unwilling to close my positions with a loss if I’m overly optimistic that the price will return and bail me out.
Most of the time, it does. My 10% rule is for those times when it doesn’t!
This, however, means that I cannot survive even a 30% swing in the price of my traded assets. In recent days, I’ve had problems sleeping with open positions as my entries were less than optimal, and the price was moving against me. There were no reliefs. There was no way to get out, or at least I hadn’t taken them, as we are in a bull market, and I was sure my trades would show me profit if I just waited a little longer.
I’ve come close to losing my margin account about five times in the last fourteen days! Somehow, I was spared that pain, but it reminded me of just how vulnerable I am to my emotions and to Mr. Market.
While there were no deeper pullbacks for months, the market changed when I loaded up on my position. Yeah, trading can feel rather personal, I can tell you that. Sometimes, you feel like someone is playing mind games with you and intentionally trying to take your money. Of course, that isn’t true, but our minds and emotions can make us feel like the whole world conspires against us.
After a really long time, I felt stressed again. Suddenly, I didn’t dare go to sleep, as my trading account looked like it would be liquidated at any moment. Alternatively, the price was going my way. I had good paper profits, but I was sure I could milk it for more. I was too bullish to take these breadcrumbs. Should I take 5% or 10% or wait for 20% in the morning?
I hate this feeling. It’s one of the reasons I usually close my leveraged day trade position before bed. Good sleep is essential. Cryptocurrency markets run 24/7, and there is always daytime somewhere in the world.
If you were sitting pretty in spot, owning your assets, and not borrowing money, even these recent 20-50% dips wouldn’t be all that stressful. We’re in a bull market, and the odds are good that you’ll see the prices return sometime in the future.
With leverage, you don’t have that luxury. You can’t wait. You don’t own those assets. Your lender does, and “they” won’t wait for better times, incurring a loss on their lent funds. They’ll pull the plug as soon as your margin is diminished.
How do you lower the stress of trading using leverage?
Same as always, by proper risk management
Either lower your position sizes or
Use stops to cut the trade when your loss threshold is reached.
You need to decide what that is - how much pain can you take? For some, it’s a loss of 100 USD, while others can take a million dollars in drawdowns without blinking an eye. I’m much closer to the first kind than the other. How about you?
If you can’t sleep with your position open, you’re doing something wrong
Either you’re not managing risk, or your positions are too large. Trading smaller and smarter will ultimately make you more money. The added bonus is that you will also experience a lot less stress trading and investing—a factor that could one day save not only your portfolio but also your life!
“Always risk only what you are willing to lose” is not just a saying
I am ultimately willing to lose 10% of my portfolio if shit hits the fan. I prefer not to, but I’m okay with it. That’s why I’ve allocated that much capital to my margin account. It’s my failsafe, my worst-case scenario. This has reduced my stress levels.
I know the devil, and I’ve made my peace with him. Always account for the possibility of a worst-case scenario happening and accept the consequences ahead of time.
The only way to live is a resolute acceptance of death, and the only way to trade is a resolute acceptance of losses.
Control what you can and let go of the rest
One cannot play with fire and not expect to get burned. The market is out of your control. It will do what it wants to do. You can, however, control just how much heat you are willing to take. In our case, how much will you lose if you’re wrong on one trade or if something goes wrong?
Good luck out there.
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