What is Margin Trading?

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What is Margin Trading?

If you’re trading cryptocurrencies, then you should be aware of different ways to trade crypto. When you look for some trading methods you will come across something like “shorting” Bitcoin, margin trading, or trading with leverage.

All these terms refer to leverage trading. The crypto margin is not something complicated. Simply put, the cryptocurrency market is volatile, wherein the price fluctuations exhibited by crypto markets make it possible for all crypto traders to gain profit in both bear and bull markets through Bitcoin margin trading. 

Now, let’s understand in detail what is margin trading, how it works, and much more.

What is Margin Trading ?

Margin trading is a trading strategy that allows traders to borrow money on an exchange against their current funds. Margin trading allows traders to amplify the total capital they are able to trade. To rephrase margin trading, it allows users to leverage their existing cryptocurrency or fiat money by borrowing funds to increase their buying power. 

For instance, in Bitcoin margin trading, you put down $25 and leverage 4:1 to borrow $75 to buy $100 worth of Bitcoins. In this scenario, the only condition is that no matter what happens, you will have to pay back $75 plus fees. To ensure to get the loaned amount back, the exchanges will  “call-in” your margin trade once you reach a price where you may start losing the borrowed money. If you want to avoid a margin call, then you can put more money into the position. 

Each exchange will have its own leveraging option like 2:1, 3.33:1, 4:1, 100:1, etc. Margin trading can be done either short or long. In short trading, you bet on the price going down, and in long trading, you bet on the price going up. 

After having a brief idea of what is margin trading, let’s understand how it works.

How does Margin Trading work?

To precisely understand the working of crypto margin trading, let’s consider the types of margin trading and their working. 

Leverage Trading

Leveraged trading works in a fundamental way. A trader gives the exchange a little bit of capital in return for a lot of capital to trade. The trader should provide an initial deposit to open a position. It is referred to as the “initial margin”. Also, the trader should maintain a certain amount of initial deposit in their account to maintain the position which is the  “maintenance margin.”

Different exchanges offer different amounts of leverage. Suppose an exchange offers 200X leverage, it allows the traders to open a position 200 times the value of their initial deposit. Every exchange has its own terminology to define leverage. It means some exchanges in the Forex market,  will refer to 100X leverage as 10:1 leverage.

Suppose you open margin trade with a cryptocurrency exchange, the amount of capital deposited to open the trade will act as collateral. Ultimately, the amount you can leverage while margin trading completely depends on the rules imposed by the exchange you choose to trade and your initial margin. 

Going Short versus Going Long

When you open a margin trading crypto position, you will have an option to choose between “short” and “long” trade. Long trade means the trader predicts the price of the cryptocurrency will increase. In short trade, it is the opposite, which means, the trader will predict the price of the cryptocurrency will decrease. Traders who seek to profit from falling cryptocurrency prices will often choose short trade.  

Always note that the exchange you trade on will hold collateral for the capital you borrow using margin trading. If you close a position at a profit, the exchange will release the profit earned and the cryptocurrency you deposited while opening the position. 

If you experience loss in margin trading, the exchange will automatically close your trade and liquidate your position. It happens when the price of your speculating asset reaches a specific threshold, which is referred to as the “liquidation price”. 

Call Prices and Liquidation

You borrow money from an exchange for Bitcoin margin trading. The exchange you choose will keep a few controls in place to minimize the risk. Once you open a trade and the cryptocurrency market will go against you, then the exchange may request additional collateral to secure your position or it may forcibly close the position. 

When such a situation occurs, the exchange will provide you a margin call. A margin call is generated when the value of an asset falls below a specific point. The exchange will then request additional funds from the trader to minimize the risks. The notifications are sent to the traders through emails. Although the traders will be notified it is necessary to actively monitor the margin levels. 

If the margin level becomes too insecure, then the exchange will liquidate the position. It is called margin liquidation level or liquidation price. Liquidation occurs only when an exchange automatically closes a position to ensure that the capital loss is only the capital deposited by the trader. 

For example, a trader opens a 2:1 long position, when the BTC price is $10,000. The position cost is $10,000, but the trader borrowed another $10,000 from the exchange. Here, the liquidation price will be $5,000. So, at this price level, the trader will lose his initial $10,000 collateral and is liquidated by the exchange.

Advantages

Margin trading is the best platform for confident traders. It is because they can open positions that are potentially more profitable than normal trading. For example, a successfully closed position at 100X leverage will yield 100 times more profit than a position opened through “normal” trade. 

It also benefits strategic traders as they can generate profit in a bear market by opening short positions. For example, if a trader predicts a significant price dip, they can potentially commit a portion of their portfolio to a short position, so as to generate a profit that offsets the potential loss occurred by a major priced dip.

Disadvantages

  • In volatile markets, the trader can lose money rapidly.
  • Margin trading is not for beginners in trading.
  • It’s a risk trading method.

Final Thoughts

Margin trading crypto minimizes the risks of exchange hacks, as leveraged trading will reduce the capital amount being held in the exchange. If you are a confident trader, whose market price predictions are accurate, margin trading crypto can increase your profits. But if you open the wrong position at the wrong time, it may damage your financial health.