Margin trading, also known as leveraged trading, refers to making bets on crypto markets with ‘leverage,’ or borrowed funds, while only exposing a smaller amount of your own capital. Margin is the amount of crypto you need to enter into a leveraged position.
How Does Margin Trading Work?
Margin trading positions can be opened as either:
- Short Position: where you bet on the price going down
- Long Position: where you bet on the price going up
In a long position, you buy a cryptocurrency in anticipation of selling it in the future when the price rises, making a profit from the price difference. This is also possible without margin. In a short position, you borrow a cryptocurrency at its current price to repurchase it when the price drops to make a profit.
Leverage and Risk
Leverage is expressed in ratios, such as 20:1 or 100:1. So, if your trading account has $2,000 and you want to open a long position with a 100:1 leverage ratio, that means you’ll need to stump up collateral – using your own funds – equal to 1% of your position size. The crypto exchange will provide the remaining 99%.
Why Trade on Margin?
If you can just hold bitcoin and benefit from its price rises, why trade on margin? There are at least three reasons.
- To Magnify Gains: Trading on margin allows you to increase your profit potential if the market moves in your favor.
- Hedging: If you hold a lot of BTC and want to reduce your exposure to the risk of bitcoin’s price going down, you may hedge (manage your risks) by opening a short position.
- Short Selling: Having a margin account allows you to short assets, which you can’t do with spot trading.
Benefits and Risks
The benefits have their own risks. While you may magnify your gains by trading on margin, you may also risk losing significantly if proper risk management is not in place. And although margin trading may help you manage risk by letting you hedge, margin interests and other transaction costs may eat into your profits.
Types of Margin
Most exchanges will offer two types of margin: cross and isolated.
- Cross Margin: Cross margin allows traders to use their entire account balance as collateral for a leveraged position. This means that if the trader’s margin balance is depleted, their entire account balance will be used to cover the loss.
- Isolated Margin: Isolated margin, on the other hand, allows traders to set aside a specific amount of funds as collateral for a leveraged position. This means that even if the trader’s isolated margin balance is depleted, their regular account balance will remain intact.
Managing Risks
Although margin trading has its appeal, it’s a risky trade set-up for beginners without a proper risk management strategy to reduce the chances of ‘getting rekt,’ or having their trading entire account wiped out. Here are some tips:
- Keep a Separate Trading Account: Allocate just a certain portion to margin trading.
- Use a Stop-Loss: Set a price level at which you want the exchange to exit the position for you, allowing you to cut losses and eliminating the risk of losing it all.
- Take Profit: Although taking profit at certain price levels reduces your overall earnings, it helps you manage risk better.
- Don’t Revenge Trade: After losing money in the crypto markets, it may be tempting to make it all back in one trade, but always assess your risks.
Conclusion
Margin trading can be a powerful tool for traders who understand its risks and rewards. However, it’s essential to approach margin trading with caution and to have a solid risk management strategy in place. By following the tips outlined above and staying informed about market conditions, you can minimize your risk of losing money through margin trading.
Sources:
- Cheguevoblin (@Cheguevoblin), August 20, 2022
- Uncle (APE certified) ? (@UVtho), June 7, 2022
