As a general rule, leverage factor and trading timeframe should be inversely correlated when margin trading. For example, a scalper using 1-minute or 5-minute charts may choose to use 10x or even 25x leverage, while a swing trader may go for a more conservative 2x or 4x leverage.
This inverse relationship is common because it usually yields the best risk-to-reward ratio for both scalpers and swing traders.
Scalpers use high leverage, short timeframes
Scalpers are traders who primarily trade with 1-minute and 5-minute charts. They find entries and exits by looking for high volatility in the immediate short term, and capitalizing on small sub-1% movements with high leverage.
For example, a trader with USD5,000 in capital and 25x leverage can control a USD125,000 position. A 0.5% price move could then generate a profit of USD625, which would equate to a 12.5% gain for the trader.
Increasing leverage reduces the gap between entry price and liquidation price. Thus, scalpers aim to enter and exit a trade in a very short timeframe to reduce the amount of time in a position and exposure to volatility.
Swing traders use low leverage, long timeframes
Consider the same trade with 2x leverage. Instead of a USD625 profit, a 2x leverage would only generate USD50 in profit with a 0.5% move – not worth it for scalpers.
As you can see in the image below, it’s fairly common for Bitcoin to wick between 0.15 and 0.5% on a 1-minute chart. As a scalper, it’s important to keep this in mind and maintain position size and leverage factor to prevent forced liquidation from this normal market movement.
Be aware that each asset has a unique personality when it comes to volatility. In other words, Bitcoin’s normal volatility range is completely different from Ethereum or XRP. Thus, it’s important to do some research and understand the “normal behavior” of an asset before trading.
Swing traders tend to gravitate towards 4-hour and 1-dday timeframes. These individuals prefer to trade mid- to long-term trends with low leverage or no leverage. A swing trader with USD5000 in capital and 2x leverage can control a USD10,000 position.
A 15% price move could then generate a profit of USD1500, which would equate to a 30% gain for the trader. Swing traders may remain in a position for days or even weeks at a time. Thus, it’s important to maintain a low leverage in order to avoid accidental liquidation from normal market liquidity.
It’s normal for crypto markets to swing 5-10% on a daily basis. If you’re a swing trader, you do not want to be caught in a situation where your liquidation price is within a few percentage points of your entry price. Lastly, trading on leverage has an associated funding cost in the form of a daily interest rate, which can add up very quickly.
Trader, analyst, Liquid contributor. Editor of Decrypto.net.