Margin trading with leverage is a method of trading that enables traders to gain greater exposure to a particular asset by allowing them to multiply the amount of capital they can trade. The terms margin and leverage are sometimes used interchangeably but to be more specific, margin refers to the loan your crypto exchange or financial institution will offer you to place larger trades which is collateralised by the funds in your account and which you will need to pay back with interest.
Margin is used by traders to create leverage which is the increased buying power that enables a trader to open larger positions than would be possible if just using the funds in their account. Leverage is expressed as a ratio, such as 5:1. For example, a margin trader who opens a trade with 500x leverage will multiply their potential profit 500 times. It is of course, important to remember that using leverage to amplify your position gives you a higher risk, although in most cases, the increase in risk is not proportionate to leverage.
Margin trading is already popular in less volatile markets such as Forex, but it has now also become very popular in the crypto market.
What is Cryptocurrency Margin Trading?
When it comes to margin trading with cryptocurrencies, the same concept applies i.e. you are trading cryptocurrencies with borrowed funds from a cryptocurrency exchange or financial institution in order to access increased leverage.
To margin trade crypto, a trader needs to provide an initial deposit to open a position. This is known as the “initial margin,” and the trader must hold a specific amount of capital in their account to keep the position, referred to as the “maintenance margin.”
All the various crypto exchanges and financial institutions will offer different amounts of leverage, for example, 200x leverage. This allows traders to open a position 200x the value of their initial deposit. Others may limit leverage to 20x or as much as 100x.
If you decide to open a margin trade with a crypto exchange or any other financial institution the capital deposited to open the trade is held as collateral by the exchange. The amount that you can leverage for margin trading will be set out in the terms laid down by the platform on which you are trading, and your initial margin.
How Does Cryptocurrency Margin Trading Differ to Spot Trading?
The usual way of trading crypto is to buy and sell cryptocurrencies on an exchange with your own funds. So, you would purchase coins or tokens at the going price and then hold onto them until the price increases, either over the short or long term, so you can sell them for a profit.
The main difference with margin trading is that you are actually borrowing money from the exchange to boost your buying power, with the potential to access higher profits.
Benefits and Risks of Cryptocurrency Margin Trading
As we have seen, the main advantage of margin trading is the potential for bigger gains. If you’re an accomplished trader with deep knowledge of the cryptocurrency markets and managing risk, margin trading can offer an effective means to help you accumulate a larger balance. Margin trading cryptos also allows traders to generate a profit in bear market conditions by opening short positions.
As with margin trading of other kinds of assets, crypto margin trading can also amplify your losses. This is the biggest risk you need to be aware of before you consider trading on margin as it is possible to lose your entire balance. Exchanges and financial institutions always require traders to maintain a minimum level of equity in their account, for example 30% of the open position. If your balance falls below this minimum margin requirement following a market move in the opposite direction to the one you predicted, you will need to add more funds to your account to avoid liquidation - this is known as a margin call. If you are not able to provide the necessary funds to keep an order open, it will be closed automatically. It is also worth noting that money borrowed to fund a margin trade is not free and you will need to pay interest on the amount borrowed as well as repay the loan amount. You should also be aware of the platform’s trading fees.
How to Margin Trade
There are two options available to a trader when opening a margin trade:
Going long. This is basically entering a long position when you buy cryptocurrency in the belief that its price will rise. Hence, leverage is used for the purpose of benefiting from increased gains if the price rises in accordance with the trader’s predictions.
Going short. This involves entering a short position, i.e. selling a cryptocurrency on the assumption that its price will go down. The aim is to then purchase that crypto back once its price has dropped and profit from the difference.
Tips for Margin Trading
If you’re a trader looking at trading with a margin account, it makes good sense to keep the following tips in mind.
Start slowly if you’re an inexperienced trader. To minimise risks, it is often a good idea for new margin traders to start by using a low level of leverage and to avoid using all funds in one transaction. Manage risks. Making use of stop-loss and take-profit orders enables you to set limits for closing positions and can help avoid problems. Research the exchange or financial institution. Some exchanges will only offer margin trading to those who match their criteria, such as ID verification or those who meet their capital requirements. It is important to research any qualification criteria prior to choosing an exchange.
As illustrated, crypto margin trading offers a number of attractive advantages. Margin trading additionally reduces any threats presented by exchange hacking incidents, since trading with leverage reduces the amount of capital that needs to be held by the exchange. If you’re confident that you fully understand the cryptocurrency market and consistently make accurate predictions regarding price movements, cryptocurrency margin trading can substantially increase a trader’s profits.
If you are looking for a crypto margin trading software, please visit the B2Margin page.