Gate.io Blog What to avoid when trading leveraged tokens?

What to avoid when trading leveraged tokens?

22 April 17:57

Since the launch of leveraged tokens , the trading community has warmly welcomed this product with open arms on Gate.io. Leveraged tokens are designed to amplify the daily performance of an underlying cryptocurrency. Despite its benefits, there are many risks that investors should keep in mind before trading leveraged tokens.

In this article, we will analyze four mistakes that you should avoid when investing leveraged tokens in order to protect your assets and avoid the risks.

1. Holding Leveraged Tokens for the long-term

One of the common mistakes we usually see is holding leveraged tokens for extended periods.

Investing in leveraged tokens for the long-term may seem lucrative, given their ability to amplify investment returns. However, there are risks when holding leveraged tokens for too long. Since leveraged tokens are rebalanced daily, and most investors fail to recognize this impact.

Depending on market movements and rebalancing, performance over time may vary. In trending markets with low volatility, the performance for periods longer than a day may exceed the return of the underlying assets. However, in volatile markets, daily rebalancing is likely to harm the token’s long-term performance.

As such, the long-term performance of leveraged tokens is unpredictable because of how the compounding effect works differently. Because of the existence of the position adjustment mechanism, the risk of holding leveraged tokens for a long time is extremely high. The longer the holding time, the greater the volatility and friction costs.

2. Ignoring the existence of volatility decay

It is completely true that during trending periods, you can increase returns on your investment, which is the primary objective of trading leveraged tokens. But when the underlying cryptocurrency decreases in value or has higher volatility, the possibility of compounding losses will be high.

Leveraged tokens are designed to amplify the daily movements of an underlying cryptocurrency. Thus, this also means that volatility is amplified by a constant leverage factor.

As a result of regular rebalancing, investors holding a leveraged token longer than a day could see their exposure levels rise or fall dramatically. Therefore, affecting their original investment.

3. Ignoring the impact of regular rebalancing

Due to its daily leverage mandate, leveraged tokens are rebalanced by reducing or increasing their exposure to the underlying cryptocurrency. Rebalancing can boost the positive effects of compounding during trending periods, but it can also magnify the negative effects of compounding during volatile periods. In addition, because rebalancing involves reducing and increasing exposure regularly, it may also result in additional transaction costs.

Leveraged tokens are easy to use but hide considerable complexity. Behind the scenes, the assets constantly rebalances to maintain a target leverage exposure. This results in additional expenses and significant fluctuations in index exposure. However, if traders predict market moves correctly and avoid the common mistakes, they will generally make money by trading leveraged tokens. It offers many viable alternatives for amplifying gains, putting less investment capital at risk, and profiting with strong market momentum.

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What to avoid when trading leveraged tokens?

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