The Brief Guide to Cryptocurrency Margin Trading
In finance, margin trading uses borrowed money from a broker to trade a financial asset, which forms the collateral for the broker’s loan. Margin is the funds borrowed from a brokerage firm to purchase a type of investment. To buy on margin refers to using the money borrowed from a broker to purchase securities. Essentially, margin trading is a way to increase more profits by adding more risks to your trades. Trading on a margin is risky because they can both bring loss or success to your investment portfolio.
Crypto margin trading explained
Margin trading in the crypto market poses higher risks than regular trading due to the volatility of cryptocurrencies. Similar to margin trading in traditional finance, cryptocurrency margin trading allows you to achieve higher potential profits by adding more risks to your trade. You do that by borrowing funds from a third party, in this case, a broker or other platforms, also known as margin lenders.
Cryptocurrency margin traders need to be more cautious, especially those new to trading or cryptocurrencies. You might get around it faster if you have prior knowledge of hedging and risk management strategies. Even if you have substantial knowledge in identifying market trends and charts, knowing the entry and exit points still won’t eliminate margin trading risks. For what it’s worth, crypto margin trading does bring new opportunities to traders. Let’s see how it works.
How does it work?
Understanding how cryptocurrency margin trading works can be overwhelming. To reiterate, we know that it allows traders to borrow capital in order to access increased buying power and open positions more extensive than their existing account balance. A trader gives the exchange platform some capital in exchange for another type of capital to trade with and make a profit from it.
Fundamentally it’s quite simple; a trader must provide an initial deposit to open a position; this is what we called an initial margin. The trader must hold a certain amount of capital in their account to maintain the position. In cryptocurrency exchange or lending platforms, the amount of capital you deposit is held as collateral by the platform. The amount you’re able to leverage for margin trading depends on the rules imposed by the platform you trade with and the initial deposit.
There are varying degrees of leverage imposed by different crypto exchanges. Some exchanges will require 100x leverage, meaning traders can open a position 100 times the value of their initial deposit. There are also other exchanges that limit the leverage to 20x or 50x.
What are long and short positions?
So you’ve heard about open positions, but what are these exactly? Typically, in crypto margin trading, you’ll find two options: going short or going long. In long positions, the trader anticipates that the price of a crypto asset will increase. Going short is the opposite, with the trader opens a short position if they believe that the price of the said crypto asset will decrease—those who are going short usually traders seeking to profit from failing cryptos.
When margin trading, the exchange you trade on will hold your initial deposits as collateral. The exchange will release the crypto you deposited and the profits if you successfully close a position at a profit; likewise, if you realize a loss when margin trading, the exchange will liquidate your position and close your trade.
Margin calls and liquidation
Besides positions, other things that you need to be familiar with are margin calls and liquidation. It is common for an exchange who provides the capital institute a number of controls to minimize risks. When you open a trade and it so happens that the market moves against you, the exchange will probably ask for more collateral to secure your position.
This is what we call a margin call. It occurs when the value of crypto asset in a margin trade falls below a certain point. The exchange will notify the trader to provide additional funds to mitigate the risk. In case of the margin level of a position becomes too risky, the exchange will liquidate. Liquidation happens when an exchange funding the trader automatically closes a position to minimize further damage. By doing so, only what the trader deposited to open the position is lost and not others.
The pros and cons of cryptocurrency margin trading
In a nutshell, margin trading in cryptocurrency could bring more substantial profits, diversifying your positions, access to more funds, and allows you to learn trading strategies. The profits may be more enormous due to the greater relative value of the trading positions. Besides, margin trading is good for diversification because traders can open several positions with a small amount of investment capital.
However, crypto margin trading’s immediate disadvantages are higher risks, significant losses, and extremely volatile. Unlike regular trading, margin trading could result in losses that exceed the trader’s initial investment; even a small drop in the market price may cause significant losses.
Cryptocurrency margin trading tips
In the traditional financial world, margin trading is considered a high-risk investment strategy and not to be meddled by inexperienced investors. Depending on the exchange you trade with, there are several tips or strategies that can be considered such as:
- Start small and increase progressively. This is a safe bet especially if you’re new to margin trading. It’s always recommended to begin with a smaller position and lower collateral.
- Set your goals. It’s essential to have a clear path to profit strategy and follow the plan. Have an exit goal and stop-loss levels, that is, the price of your asset reaches a certain level.
- Check the fees and interest. Crypto exchanges that support margin trading will not do it for free. As you open a leveraged position, there will be interest on capital you borrow as well as other fees as well.
- Don’t overlook the external factors. There could be regulatory changes, major crypto wallet movements, or even exchange hacks, that could create unexpected price changes.
Cryptocurrency margin trading exchanges
It is not always necessary to trade on the highest leverage platform. There are other factors that you should consider before choosing to margin trade with an exchange, such as how high the interest rates are. BitMax is a popular exchange that offers up to 100x leverage while offering varying interest rates from 3.65% per year or 0.01% per day, making it ideal for short-term positions.
CEX.io allows both crypto margin trading and fiat deposits, that way you can withdraw from an account via wire transfer or paying using credit cards. Other popular options for exchanges include PrimeXBT, BaseFEX, and ByBit.
Getting the funds from crypto lending
If you’re a trader and looking for more funding sources, an alternative worth looking into is crypto lending. Many crypto lending platforms such as Hodlnaut, BlockFi, or Celsius Network allow traders to borrow assets to arbitrage or margin trade. These platforms usually have customized terms and flexible loan-to-value. As always, read the fine prints before getting a loan.
All in all, and despite the risks, cryptocurrency margin trading is a fascinating avenue for traders, individual investors, and crypto enthusiasts, in general, to aid in profitability and portfolio diversification.
This article is originally published at Coinmonks.
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