Do you consider yourself a risk-taker? Are you willing to increase your exposure to markets with the little or much you have? If that’s you and your preferred product is crypto, then margin trading may be what you’re looking for.
Spoilers alert, though; margin trading is an investment strategy that promises great wins or stupefying losses. So, buckle up as we explain all you need to know about margin trading in cryptocurrency, including the gains and risks involved.
Basics of Margin Trading with Cryptocurrency
Let’s start with the basics; what is margin trading?
Simply put, margin trading is where a small amount of money or a similar financial tool controls a much larger financial position. In margin trading, the trader borrows funds as leverage to use in regular trading accounts.
In comparison with other trading methods, margin trading opens the door for a much larger capital base, amplifying the trading results. As enticing as it sounds, the amplified trading results could go either way for the trader, thus making this option particularly risky for novice traders. What we mean is, traders may realize exponentially greater profits once the trade is booming. The same holds if the trade goes down south.
So, How Does Margin Trading Work Using Cryptocurrency?
Investment brokers act as the funders in traditional markets. However, in cryptocurrency trading, other traders will provide the leverage for the Margin funds. These traders then earn interest according to the demand in the forex market for the Margin funds. That said, there are fewer cases of cryptocurrency exchanges that fund Margin trading capital to their users.
Most exchanges offer expansion levels from between 5х to 125х the amounts used to open the account. This poses a higher risk level as well as an opportunity for higher profits. Margin trading in cryptocurrencies is even riskier since the cryptocurrency market is more volatile. Once the trader begins trading in cryptocurrency, they can either opt to take long or short positions.
First things first, the trader deposits an initial deposit to create an open position. This is known as the initial margin. To maintain that position, the trader must hold a certain base amount in Margin trading at any given time. The lending platform will then use this deposit as collateral to fund you a higher capital base. The multiplied amount used to purchase the desired financial instrument or the full value of the opened position is known as the margin. Anytime the margin falls below the maintenance threshold, the trader will need to deposit more funds to avoid liquidation.
Note that different platforms have different rules for trading with the initial deposit. The trader must familiarize himself/herself with these rules before embarking on Margin trading. The exchange will only release the collateral upon successfully closing a position at a profit. However, should you close your position at a loss, the exchange will liquidate your position, which may carry extra fees.
Talking about fees, the exchange charges you a set fee for taking the loan as well as a commission for the amounts earned in margin trading.
Example of Margin Trading in Cryptocurrency
Duplex anticipates the price of Bitcoin to rise from the current $10,000. But Duplex only has $100 to start the trade. So, Duplex decides to take a long position in cryptocurrency margin trading. He receives a 20х leverage, thus, for every $20 needed to purchase the BTC, he only has to invest $1 into his account. The exchange compensates for the remaining amount.
With only $100, Duplex cannot purchase a single BTC even with a 20х leverage. Duplex puts down $75 for the deal as collateral and receives $1,425 from the exchange. The platform has a trading fee of $2 plus a commission of -0.0100% for the leverage. Using this, Duplex can comfortably purchase 0.15 BTC under Margin trading.
Assuming the price of BTC goes up by 2%, Duplex will gain a profit of 2% of $1500. That equals $30 on top of his initial Margin trading investment. This represents 40% of the collateral, a higher profit margin than would be realized under regular trading.
What are the Perks and Cons of Margin Trading in Cryptocurrency?
While Margin trading can be profitable when done right, it is a double-edged sword that poses significant risks. As such, expert traders can apply some simple tips and strategies when engaging in Margin trading. We’ll cover this in our next article.
Let’s now look at some advantages and disadvantages of Margin trading in cryptocurrency.
|Possibility of greater profits||Could end up in more significant losses|
|Traders can diversify portfolios quickly with smaller amounts||Diversification comes with high-risk trading|
|Limited starting capital can translate to more funds||Margin trading translates to volatile markets, thus the possibility of quickly losing funds more funds than the initial deposit|
|It is ideal for professionals mastering the art of risk management||Margin trading is more challenging and riskier for newbies|
Think of Margin trading as a step up from spot trading. It exposes the trader to a greater value of assets which opens the door for diversification into diverse markets. It isn’t complicated really but it calls for a great deal of caution. Small fluctuations in the market could result in astronomical losses due to the leveraging component. Expert traders love this trading method as limited funds could translate to greater purchasing power and in turn, more profits. That said, it would be advisable to learn the basics of trading before embarking on Margin trading.