How does losing money (under margin) work?

Question

I am trying to understand how loss of money works when one uses margin.

In the picture below, if price goes into the green area, I make money. If it goes into the red area, I lose money.

Suppose I purchase BTC at 10X (ex:$2000 @10X would be $20,000). I want to "go long". When I buy the Bitcoin, it is priced at $10,000. So - with my $20,000 - I now, I have 2 Bitcoin.

Now, suppose the trade "moves against me" and price goes down to $9500. Thankfully (as an example), $8500 is the Liquidation Level - so - I am not totally done for. If I sold then and there (at $9500), how can I calculate how much money I would have lost?

Answer 1

To put it very simply, a 10X leverage means that if your asset drops 10% you have lost 100% of your money.

ABC (whatever the target asset) trades at 10,000. If you only put up 1,000, a 10% drop wipes you out. A 10% rise doubles your bet.

At 9,500 you've only lost half your money. The percent loss is literally multiplied by 10.

To put it in a formulaic approach, an N leverage results in a total loss if the purchase drops by (100/N)% e.g. a leverage of 2 (typical stock market margin acct) would take a 100/2 or 50% drop to lose your funds. Leverage of 5, 20% drop wipes you out, etc. The simple way to view it is that the loss is multiplied by the leverage number. When that product equals 100, game over.

Edit: Respectfully, the OP's comment below is very concerning. I hope he is educating himself enough to fully understand the risk before entering any trade. To some, the math may appear simple, to others, it takes time and perhaps the use of a simulated trading account. I'll withhold judgement on crypto, this point is the for stock trading on margin or the use of options in one's trading.

Answer 2

With margin you always owe what you borrowed. The gain or loss is all yours. To buy $20,000 worth of Bitcoin you supplied $2000 and borrowed $18,000. The Bitcoin is now worth $19,000 and you still owe $18,000. The Bitcoin lost $1000 worth of value total so you now have $1000 less than you started with.

Note most brokerages won't allow you to have such high leverage. Usually they limit the margin cash available to something like 1x what you supplied. The numbers in this example are not realistic. $8500 couldn't be the liquidation level because your equity in the investment would be negative (i.e. you'd have lost more money than you put in). This situation would never be allowed.

Answer 3

10x leverage means your profits are 10 times more and your losses are 10 times more.

So imagine what your profit or loss would have been if you didn't have any leverage.

If you would have made $100 profit, then with 10x leverage, you've made $1000 profit.

If you would have taken a $100 loss, then with 10x leverage, it actually ends up being a $1000 loss.

Technically, you can go into debt. If you only own $2000 and take a $2500 loss, you are $500 in debt.

With most exchanges, the liquidation engine kicks in to prevent you from going into debt. There is generally a slight fee for this added safety, meaning your account balance will be left with $0 even if you are liquidated before going into debt (for example while you still have a $50 balance).

In the worst case scenario where the engine fails to liquidate you on time (and you do go in debt), then the debt will be paid by the exchange's insurance fund. If for some reason this fund is empty, then the exchange will take the hit and might not be able to pay out profits for users.

Answer 4

If you deposit $1000 into a trading account with 10x leverage, you have $10,000 of purchasing power to buy securities or currencies.

You are borrowing the "margin" money

You can buy $10,000 worth of Bitcoin into this account. $1000 of the money will be yours and $9000 will be loaned to you at an interest rate.

If the value of that Bitcoin rises to $20,000, you can sell the bitcoin then, and the sales proceeds will be $20,000. You will pay back the $9000 loan and have $11,000 profit.

If the value of the Bitcoin falls to $5000, and you sell the bitcoin then, you will gross $5000, and you will pay an additional $4000 to settle out the $9000 loan, and be totally wiped out. Except that will not be allowed to happen, because the broker will not trust you to voluntarily pay the additional $4000.

If the value of the Bitcoin falls to $9500, that means that there's $500 of your own money into it, and $9000 of the broker's. There's a big problem: You are now 19x leveraged - you have only $500 of your own cash but $9000 of their cash at risk. That wasn't the agreement!

Margin call

So the trader is going to make a margin call at this point. A margin call requires you to pay $500 additional cash into your account so that to bring your borrowing back to 10x as agreed. You can accomplish that by selling some of the Bitcoin.

If you refuse to do that, they will force sale of some of the Bitcoin. At this money-losing price for you.

So if Bitcoin is going down, down and more down... this would trigger repeated forced sales due to the margin calls. These sales would occur at lower and lower sale prices.

So these margin-call sales are "locking in" your losses.

Answer 5

That you bought on margin isn't really relevant to calculating your loss. You bought 2@10k, and you sold 2@9.5k. 2*10k-2*9.5k = 20k-19k = 1k. You can also calculate it as a percentage loss: going from 10k to 9.5k is -5%, and 5% of 20k is 1k. Now, if you're comparing the percentage loss against your initial payment of 2k, that's where the leverage ratio comes in: you lost 5% on 2k, but with a delta of 10, so that's 5%*2k*10 = 1k.