Margin trading is a high-risk trading strategy that allows traders to borrow funds to speculate on the future performance of an asset. There is a huge amount of money to be made in cryptocurrency margin trading. But you need to know what you’re doing because although your gains are multiplied significantly, so too are your losses. Here’s what you need to know about margin trading.

The trading practices present in both crypto and traditional markets can get confusing quickly. At first glance, margin trading can be overwhelming for newer traders. The practice of trading with leverage, commonly referred to as margin trading, is saturated with terms such as margin calls, liquidation, leverage, shorting, and more.

Margin trading with cryptocurrency doesn’t need to be complicated, however. The basic premise of crypto margin trading is that the high volatility of the cryptocurrency market provides traders with the opportunity to generate profit in both bull and bear markets.

Did you know?

The phrase “going long” or opening a “long position” means that a trader is speculating that an asset will increase in value. Conversely, “shorting” or opening a “short position” means that a trader believes an asset will drop in value.

What is margin trading?

In simple terms, margin trading or “margin investing” allows traders to borrow funds in order to increase their buying power. Using this method, traders have access to more money to make significantly larger trades, and as a result, potentially much bigger gains. Margin trading, however, can expose traders to extreme risk.

In normal cryptocurrency trading, traders can only use the funds they have in their trading account. However, with margin trading (also known as leverage trading), traders can multiply the amount of money they are able to commit to a position by taking out a margin loan from the exchange or other traders. This form of trading typically occurs in a crypto margin trading exchange.

Margin trading significantly amplifies the exposure a trader has to the market and therefore increases risk. It is a bit like gambling at a casino. If you walk in not knowing what you are doing, you could lose it all in a heartbeat. But if you know the system, the games, and you have a strategy, you’ll have a much better chance of winning big or at the very least, minimizing your losses.

Did you know?

The term “leverage” in the context of margin trading refers to the amount by which traders are able to multiply their position. For example, a trader using 100X leverage has 100 times the trading power as their initial investment.

How does crypto margin trading work?

Trading on margin is relatively straightforward. When opening a leveraged position, a trader must provide an initial investment as a deposit into their margin account. This deposit is referred to as the “initial margin.” The trader must maintain a specific amount of capital in their account in order to maintain the margin position they have opened, which is referred to as the “maintenance margin.”

Crypto exchanges typically hold collateral for the money borrowed by margin traders. In the event a position is successfully closed, an exchange will release the assets deposited as collateral in addition to any profits. Realizing a loss while margin trading, however, typically results in an exchange automatically closing the trade and liquidating the position. This means that the trader’s speculation was wrong and as a result, they lose their initial investment. Think of it like a failed bet on a horse race. The person betting does not win any prize money, nor are they reimbursed the money it cost them to place the bet.

Margin calls and liquidation

When a trader opens a leveraged position by borrowing funds from an exchange, the exchange enforces a variety of rules that are designed to minimize risk. If a trader opens a position and the market subsequently moves against them, the exchange may request that the trader provide more funds in order to keep their position open. If the trader does not provide additional capital, the exchange is likely to forcibly close the trade.

In this scenario, an exchange will issue a “margin call” to the trader. Margin calls occur when the value of the asset a trader is speculating on falls below a specific price point, at which point the trader must provide additional collateral. Most exchanges provide margin call notifications but it’s generally the responsibility of the trader to actively monitor margin levels.

Should the margin level of a trade fall below a specific threshold, the exchange will liquidate the position. This is referred to as the “liquidation price” or the margin liquidation level. In this example, the exchange will automatically close an open position to ensure that only the capital deposited by the trader is lost.

What are the benefits of margin trading?

Margin trading can be very appealing to traders because it unlocks the potential for much larger returns than they would have access to using their own funds. For instance, the profits generated from a successful 100X leveraged trade are 100 times greater than the same position opened via a normal trade without leverage.

Common crypto margin trading strategies

While margin trading offers traders the possibility of increased profits, it’s generally regarded as a high-risk trading strategy that can be greatly impacted by short-term market trends and price movements. When compared to traditional securities markets, the cryptocurrency market is far more volatile, and therefore exposes traders to additional risk.

The following strategies and practices should be taken into consideration before margin trading:

  • Progressively increase commitment: If you’re new to trading with leverage, start margin trading only with small position sizes or low leverage.
  • Practice with paper trading: Paper trading, or demo trading, provides traders with the ability to practice opening leveraged positions in a virtual exchange environment without risking real money.
  • Spread risk across multiple positions: Many margin traders minimize risk by dividing a position into multiple assets. Implementing a ladder of take-profit levels can assist with minimizing risk.
  • Take advantage of complex order types: Stop loss orders and take profit orders can assist margin traders in opening complex positions or minimizing risk. Different order types can automatically close positions at predetermined profit or loss targets.
  • Take note of the margin interest rate and trading fees: Trading platforms don’t provide additional capital for free — traders that open leveraged positions pay interest on the capital they borrow from exchanges. Factor interest and fees into profit calculation.

Crypto margin trading risks

Bitcoin margin trading is huge within the cryptocurrency market. But margin trading Bitcoin and cryptocurrency do expose traders to a number of unique risks that are present only in the crypto market. When compared to the traditional stock market, the cryptocurrency market is subject to far less regulatory scrutiny.

If the market is saturated with long or short positions, market movers (traders that have enough of an asset to influence market trends) may be able to sway price movements. These traders, in some scenarios, may be able to create market positions that force the liquidation of these positions.

The fast-moving and volatile nature of the cryptocurrency market creates a trading ecosystem that places heavy emphasis on short-term leveraged positions. Traditional markets move far slower than cryptocurrency markets — extreme variance in asset prices can occur in a single day, potentially resulting in margin calls.

Important to remember

Opening a position with high leverage carries a corresponding amount of risk, especially during a period of market volatility. A high leverage position, for example, will have a narrow liquidation window. It’s critical to determine the amount of price movement that would result in your position being liquidated before opening a trade.

Summary

Margin trading provides traders with the ability to significantly increase profits if executed successfully. In addition to increasing your crypto investment, margin trading also reduces the total amount of capital that must be deposited onto an exchange in order to trade.

Confident traders that consistently and accurately identify trends within the cryptocurrency market can potentially trade with margin in order to multiply profits. The wrong position opened at the wrong time, however, can result in near-immediate liquidation. Always carefully assess liquidation risk and perform due diligence before opening leveraged trading positions.

If you want to learn more about trading strategies, there is lots of useful information on the Swyftx Learn platform.

Written by Ben

Written by Ben

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