What is Margin Trading?
7 mins read
1 yrs ago
Cryptocurrencies are digital currencies created to facilitate financial transactions around the globe. However, cryptocurrencies aren’t just a replacement for fiat currencies. Many people consider them to be assets that can be traded to earn a profit. In order to maximise profit, there are a number of strategies cryptocurrency traders can employ when trading. One such trading strategy is called margin trading.
What is Margin Trading?
A margin is a financial tool used by traders to increase their investment power. A margin refers to a borrowed asset (in this case, cryptocurrency) that is used for investments with the hope of earning more profit. These assets are often borrowed from the financial institution that is being invested with. As with other conventional loans, the cryptocurrencies are paid back to the financial institution with interest. Individuals, through the use of these assets, can leverage significant sums of capital to earn more profit.
Margin trading allows traders to expand their trading reach by using funds provided by these financial institutions. For instance, a trader can experiment with various cryptocurrencies using these new funds he now has access to, which his initial capital may not allow. However, it is essential to note that the volatility associated with cryptocurrencies may make margin trading a riskier initiative for crypto traders. This is because they may experience loss on these loaned funds. Nevertheless, margin trading can be very profitable, as it can generate multiple streams of income for traders.
Crypto enthusiasts who are just getting on board the crypto train need to be more cautious with margin trading if they don’t have substantial knowledge of trading strategies. It is important to note that the risks are heightened in margin trading.
How Margin Trading Works
Margin trading is a bit more complicated than just heading to the financial institution you are investing with to get a loan. A trader, in order to get access to this loan, needs to provide the exchange with collateral. The collateral in this case is another form of capital. In essence, the trader exchanges one capital to receive another capital.
This is how it works: the trader provides an initial deposit to the financial institution. This initial deposit is called the initial margin. Therefore, a crypto trader who wants to implement margin trading must already hold a certain amount of crypto with the crypto exchange. These funds are held as collateral by the lending platform and the amount you can access from the lending platform is dependent on this initial margin and other policies in place. Apart from your initial margin, you may also be required to hold a specific amount of funds in your account to maintain your position; these funds are referred to as “maintenance margin.”
The capital that is offered to you by the crypto exchange is referred to as leverage. You may be able to get up to 200X from the crypto exchange or as low as 10X. 200x means that the crypto exchange allows you to trade 200 times the value of your initial margin.
What are long and short positions?
Traders who partake in margin trading are provided with an opportunity to either “go long or short". Long positions centre on anticipating the price increase of crypto assets. Therefore, traders who go long are on the lookout for crypto assets that have the potential to increase in value. Short positions are opened in anticipation that the price of a crypto asset would fall, therefore, traders who open short positions are interested in failing cryptocurrencies.
However, it is important to note that you would only receive the crypto you deposited and your profit only if you are able to close either of the positions in profit.
Understanding Margin Calls & Liquidation
A trader who decides to participate in margin trading needs to hold an initial deposit which is referred to as initial margin. However, there are certain conditions a trader needs to be aware of before taking part in margin trading. The initial deposit is held as collateral which means that if you experience a loss, you would lose your collateral. However, the crypto exchange or lending platform can do a lot more than just withhold your collateral.
If you experience a loss in a position, then the exchange would automatically close and liquidate your position. When you open a position, a limit is set and if the losses incurred reaches that limit your position would be liquidated. This is one of the controls the lending party has over your account to minimise losses.
The exchange may also decide to request more collateral from you, to keep your position open. If you fail to provide the needed collateral then the exchange can forcibly close your position. However, before this is done, you would receive a margin call. The margin could be received by email letting you know that your position has reached its threshold. You would be provided with the conditions to keep the exchange position open. However, if the position has become too insecure then you may not receive an option to keep the position open.
In this situation, the exchange would forcibly liquidate the position to minimise loss on their part. Therefore, the exchange doesn’t experience much loss; the larger loss experienced is the loss of your initial capital.
Advantages of Margin Trading and Possible Downsides to Margin Trading
Margin trading allows a trader to generate more profit as they can open positions that are larger than their initial capital. It also allows for diversification, as traders can afford to open several positions with the leverage received from the exchange. Traders can quickly enter and exit the market with the funds received from the exchange. It allows you to maximise trading strategies to maximise your profit.
However, with more profit comes greater risk. With margin trading, you may experience a loss that exceeds your initial deposit. For instance, a shift in market position can have you experiencing a loss you might find difficult to handle. Therefore, traders are advised to implement risk management strategies to minimise losses. Margin trading is much riskier because of the volatility of the market, so it is important that you are prepared before opening a position.
Additional Tips You Need to Keep in Mind for Margin Trading
Although margin trading may be considered highly lucrative, it is best as a short term investment because of the high volatility of the crypto market. However, there are certain steps you can take to help minimise losses and maximise profits. These include:
- Set trading goals
It is important that you set trading goals, especially if you are new to margin trading. You should set profit goals and adhere to the goals so you can exit the market at the optimal position. You may also set a personal limit apart from the one set by the exchange to minimise losses.
- Check the fees and interest rates
Margin trading comes with certain fees that you need to be aware of. There is also an interest rate attached to margin trading. It is important that you put this into perspective in calculating if margin trading would be profitable for you. This is because these fees and interest may incur costs that cut into your profit.
- Start small and progressively increase your trading size
It is best that you start with smaller positions and lower collateral to minimise risks, especially if you are new to margin trading. When you develop a better understanding of what it entails, you can increase your trading size to make more profits.
- Diversify your positions
It may be helpful to spread the leverage into separate positions. This would help lower your risks and create an avenue to maximise profits from diversification into separate positions.
- Pay attention to external factors that may shift the market.
The crypto market is highly volatile, but there are certain triggers such as regulatory changes and crypto wallet movements that may cause a price shift. It is best that you pay attention to these external factors so you know the optimal time to enter and exit a market.
What is Margin Funding?
Margin funding is a strategy employed by investors to earn money through funding margin trades. Certain crypto exchanges offer an avenue for investors to earn through margin funding; that is, setting aside money to fund the margin trades of other traders.
There are certain conditions the investor must meet to enjoy the benefits of margin funding. Investors earn a passive income from the interests paid to the exchange. The risks in margin funding are minimised because exchanges implement margin calls and can liquidate positions to minimise losses. However, investors would have to lock up their funds in a wallet and may not be able to withdraw at will. Therefore, it is important to familiarise yourself with the policies of the crypto exchange and the risks involved before investing in margin funding.
Crypto exchanges that allow Margin Trading
Although several crypto exchanges offer an avenue to margin trade, not all of them do. Crypto exchanges that allow this feature include:
BaseFEX offers its users up to 100X leverage on their initial deposit. However, depending on the length of your position and the leverage you get you may have to pay considerably high interest rates.
BitMax (now AscendEX) is another popular exchange that offers up to 100X times leverage but at a notably low interest. Traders can access leverages for as low as 2.6% interest per year and 0.01% per day.
Traders implement risk management strategies such as stop-loss orders. ByBit, apart from allowing its traders up to 100X leverage, allows them to implement these strategies in running their accounts.
Cex.io allows its traders to enjoy the benefits of both crypto margins trading as well as fiat deposits. Traders can deposit and withdraw from their account using fiat currencies and can easily make credit card payments or wire transfers.
Other popular crypto exchanges that offer the margin trading feature includes OKEx, Kraken, Huobi, Simex, Phemex and Coinsbit.
Crypto margin trading is an impressive avenue for traders to increase profits and diversify in the crypto space. Although it can be highly risky due to the volatility of the crypto market, given the right tools and strategies traders can increase their overall profit. However, it is important for traders who are new to margin trading to start small and then progressively spread to other positions to minimise losses. Traders who find margin trading highly risky may consider margin funding as an alternative investment or lending from a crypto exchange. In conclusion, margin trading can be highly profitable but can also be highly risky.
Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.