Simply put, spot trading and leveraged trading are two different ways to trade in financial markets, each with different levels of risk and opportunities.
Spot Trading
Concept:
Spot trading is the buying and selling of assets (such as cryptocurrencies, stocks, commodities) at the current market price, and the asset is delivered immediately or within a very short period (usually 1-2 business days). When you buy an asset in the spot market, you become the actual owner of that asset.
How does it work?
* Direct Purchase: You buy the asset and pay its full value.
* Ownership: You become the actual owner of the asset.
* Profit and loss: Profit depends on the increase in the price of the asset you bought, and loss depends on its decrease. You only gain or lose the amount of the change in the price of the asset you own.
* No leverage: You do not use borrowed money from the broker.
Advantages of Spot Trading:
* Lower risks: Since there is no leverage, the risks are limited to the capital you only invested. You cannot lose more than you invested.
* Actual ownership: You can hold the asset you bought for a long time or use it for any other purpose.
* Simplicity: Spot trading is considered simpler and easier for beginners.
Disadvantages of Spot Trading:
* Limited profits: Potential profits are directly proportional to the size of your investment. To achieve large profits, you need to invest a large capital.
* You cannot profit from falling prices: You can only make a profit when the price of the asset rises.
Example:
If you bought 1 Bitcoin at a price of $40,000 in the spot market, you own 1 Bitcoin. If the price rises to $50,000, you can sell it for a profit of $10,000. If the price drops to $30,000, the value of your investment drops to $30,000, and you would have lost $10,000 (if you sold).
Leveraged Trading
Concept:
Leveraged trading (also known as margin trading) allows you to control a larger amount of assets using a relatively small amount of your own capital. This is done by borrowing money from the broker (exchange) to increase your buying or selling power.
How does it work?
* Borrowing: You borrow money from the broker to open a trade larger than your actual capital.
* Margin: The small amount you deposit to open the trade is called "margin."
* Leverage: The ratio between the total size of the trade and the capital you deposited (margin). For example, a leverage of 1:100 means that every dollar you deposit allows you to control $100 of the asset's value.
* Amplification of profits and losses: Leverage amplifies potential gains but also amplifies potential losses.
Advantages of Leveraged Trading:
* Higher potential profits: You can make substantial profits even from minor price movements because you are trading with a larger volume than your capital.
* Ability to short sell: Allows you to profit from falling asset prices by selling an asset you do not own (borrowed) and then buying it back at a lower price.
* Capital efficiency: You can open large trades with relatively small capital.
Disadvantages of Leveraged Trading:
* Very high risks: Losses can exceed the capital you deposited, potentially leading to complete liquidation of your account (Margin Call).
* Margin Call: If the market moves significantly against you, the broker may ask you to add more funds to your account to keep the trade open, or else your trade will be automatically closed.
* Fees and Interest: You may incur financing fees or interest on borrowed funds, especially when holding trades for a long time.
* Greater complexity: Requires a deeper understanding of the market and risk management.
Example:
If you have $1,000 and expect the price of Bitcoin to rise, and you decide to use a leverage of 1:100. This means you can control a trade worth $100,000 ($1,000 * 100).
* If the price of Bitcoin rises by 1%: In spot trading, you earn 1% of $1,000 = $10. In leveraged trading, you earn 1% of $100,000 = $1,000 (which means you doubled your original capital).
* If the price of Bitcoin drops by 1%: In spot trading, you lose 1% of $1,000 = $10. In leveraged trading, you lose 1% of $100,000 = $1,000 (which means you lost your entire original capital).
Key Differences:
| Feature | Spot Trading | Leveraged Trading |
|---|---|---|
| Ownership | You physically own the asset | You do not physically own the asset, but speculate on its price |
| Leverage | Not used | Used to amplify the size of the trade |
| Risks | Limited to the invested capital | Very high, can exceed the invested capital |
| Profits | Limited to the size of the original investment | Very potential, but with amplified risks |
| Complexity | Simplest and easiest for beginners | More complex, requires deeper understanding and strict risk management |
| Short Selling | Not possible (unless there is a specific lending mechanism in the market) | Possible, allowing profit from falling prices |
| Fees | Usually low trading fees | May include financing fees and interest on borrowed funds |
Conclusion:
Spot trading is the safest and simplest option for beginners, as it allows you to own the assets and control the risks. Leveraged trading offers greater opportunities for huge profits, but it comes with very high risks, making it suitable for experienced traders who fully understand how to manage risks. It is always essential to fully understand the risks before engaging in any type of trading.