When forced liquidation strikes
If you’ve ever wondered what the downside to trading with borrowed money looks like, cast your eyes on the latest bitcoin crash. Part of the selling pressure came from leveraged traders who bailed, not because they wanted too, but because they HAD to.
According to data from Bybt.com, more than 775,000 traders had their accounts liquidated between May 18th and May 19th when Bitcoin’s price plunged from $45k to $30k. The dollar amount of crypto was about $8.6 billion.
You can talk about diamond hands, laser eyes, and HODLing all you want, but if you’re playing with borrowed money -which is what buying on margin is – then you’re going to get knocked out every time a nasty bear comes along.
Unlike the stock market, which only allows you to buy on 2:1 margin, some bitcoin brokers allow you to use 20:1 margin or more. That means for every $1 you put in, they let you purchase up to $20 of crypto. It’s insane and a surefire way to the poor house if prices move against you. Here’s my favorite way to look at it. How much adverse movement would it take to wipe me out? That is, to cause a 100% loss?
No margin: -100%
2:1 margin: -50%
3:1 margin: -33%
10:1 margin: -10%
20:1 margin -5%
To be clear, if you use 20:1 margin, all bitcoin must do is drop 5% and you lose all your money.
From peak-to-trough, bitcoin just fell 54%. Legions of margin-wielding speculators blew up. The lesson here is clear: Using margin on an asset that you’re trying to invest in is like shooting yourself in the foot just before running a marathon. You’re not going to make it to the finish line.
Chart of the Day
The Bitcoin Crash
Notice the volume super spike on May 19th. A portion of the “pukers” were leveraged traders being forced to liquidate because of their ill-advised use of margin. Sadly, some didn’t learn their lesson and will be back to blow up during the next volatile event.
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