With the rise in popularity of cryptocurrencies, margin trading on this volatile asset has opened up new and potentially lucrative possibilities. In this article, we’ll show you how crypto margin trading works. We’ll also go over the advantages and disadvantages of crypto margin trading, as well as how to get started.
What is margin trading?
Leverage is used in crypto margin trading to multiply the results of a trade. The margin is the amount a trader has deposited in their account. A margin trading broker will give traders a leverage quotation, which is commonly displayed as a ratio (e.g., 1:5) or a multiple (e.g., 5x), indicating that for every 1 Bitcoin (or other base cryptos) placed, they will get 5 Bitcoin (or another base crypto) back.
The broker permits traders to borrow money to open more visible positions. This will have to be repaid in full, but the trader will keep the gains. If your leverage is 1:5, you’ll have $5,000 to trade with if you deposit $1,000. If you use this to buy Ethereum and the price rises 5%, you’ll end up with $5,250 in ETH. If you complete your deal at that point and repay the $4,000 borrowed, you’ll be left with $1,250 and a profit of $250. You would have made a $50 profit if you had executed the same trade-in in your spot account.
If the crypto price goes awry after you open your position — say, down instead of up — the crypto exchange will “margin call” your trade when the price reaches a point where you begin losing the borrowed funds. So you’d have to continue increasing funds above that threshold to avoid getting margin calls and losing your trade.
Why trade on margin?
- Short sales: Short selling frequently employs the concept of margin. For example, when you short sell cryptocurrencies, you’re betting that their price will fall, a process known as “shorting.” Trading on margin increases the size of a temporary position and thus its earnings. However, if the deal goes wrong, the potential for losses might be significant.
- Managing risk: Traders also use margin as a risk management strategy to limit or hedge their losses as a risk management strategy. You can, for example, hedge a long bet on the price trajectory of an asset by shorting the same asset with an equivalent or lesser amount.
Assume you have $10,000 in your trading account, and your broker permits you to borrow up to 50% of that amount, or $5,000 in the margin. The value of your trading account rises to $15,000 as a result. You could get $150 if your purchased shares grow 10%. Conversely, if they fall 10%, you’ll lose $150, or $50 more than if you hadn’t borrowed anything at all.
How does margin trading work in cryptocurrency?
Cryptocurrency trading, let alone crypto margin trading, is not offered by most traditional brokerages. Because of the volatility of cryptocurrencies, individual traders have been deterred from making large bets with margin trading funds. Institutional investors, according to statistics, do 70% of all current cryptocurrency trading using API calls. In place of brokerages, cryptocurrency exchanges have become popular places to trade on margin. However, this service is not available in all exchanges.
For the exchanges that allow margin trading, leverage amounts and interest rates vary depending on customer demand and regulatory variables in various geographical jurisdictions. Some European exchanges, for example, allow for up to 125X leverage on specified futures contracts. Furthermore, margin loan interest rates change with the currency rate. Some lenders, for example, impose an annual interest rate, while others charge an hourly rate.
According to a prevalent misperception regarding trading on margin with cryptocurrency, individual traders can perform arbitrage techniques between different geographical areas. However, this isn’t accurate: Some regulated cryptocurrency exchanges only allow nationals or expatriates living in the country to trade. Moreover, by adhering to strong Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations that require proof of identification of each user who uses the exchange platform in that country, exchanges assist in the implementation of all-important regulatory and compliance rules.
Tips to keep in mind when trading cryptocurrency on margin
To begin with, the bitcoin asset class is not uniformly regulated throughout the world, which might be detrimental to your trade. For example, a cryptocurrency exchange ban, such as the one enforced by China in 2017 could ruin the value of your assets.
Second, bitcoin and cryptocurrency tokens represent a novel asset class, with price fluctuations that previously followed unpredictable patterns with little to no link to conventional markets’ technical or fundamental analytic ideas. Margined bitcoin trades may result in more enormous gains or losses, so margin trading should only be done by experienced traders familiar with risk management.
Finally, margin trading necessitates an in-depth knowledge of the worldwide bitcoin market. There are practically hundreds of bitcoin exchanges all around the globe. Unfortunately, some of them are not trustworthy, and using them might lose your invested funds. As a result, before you consider margin trading, especially bitcoin margin trading on a crypto exchange, you should extensively investigate the platform you intend to utilize.
What are the pros and cons of cryptocurrency margin trading?
Margin trading in cryptocurrencies can help you make more money, diversify your holdings, have access to more funds, and discover new trading tactics. On the other hand, crypto margin trading has several immediate downsides, including more significant risks, massive losses, and high volatility. In addition, unlike conventional trading, margin trading can result in losses that are greater than the trader’s initial investment.
The pros of margin trading cryptocurrency
Lower capital needs — Some Bitcoin trading tactics necessitate a massive sum of money. Scalping, for example, is the practice of making frequent modest profits by making quick and sharp trades. On the other hand, crypto margin trading allows traders to get the most out of each trade and swiftly build profits.
Margin trading is available around the clock — Unlike the FX and commodities markets, crypto can be traded 24 hours a day, seven days a week. If you’re a weekend trader, this means you can do margin trading outside of regular business hours.
The cons of margin trading cryptocurrency
Losses are magnified — While trading crypto on margin might result in higher profits, that also means that any losses are compounded. Compared to trading on a cash account, losses can exceed the deposit amount, so the risk is substantially higher. As a result, traders should think about whether or not they can afford to take the risk.
Interest on borrowed cryptocurrency — While traders keep all profits from their deals, some exchanges impose interest on the amount borrowed. The interest rate changes depending on the cryptocurrency and the length of time the money is borrowed.
Trading pairs are limited — Leverage isn’t available on all crypto margin trading platforms; in some cases, it’s only available on one or two. This restricts traders’ ability to use an arbitrage technique.
Tips for cryptocurrency margin trading
Margin trading is regarded as a high-risk investing strategy that inexperienced investors should not attempt in the traditional financial world. However, depending on the exchange you trade with, there are numerous recommendations or techniques to consider, such as:
Reduce the number of trades you make — This is an excellent place to start if you’re new to margin trading. Beginning with a minor position and less collateral is always a good idea.
- Gradually increase trade size — This is especially useful for beginner margin traders: starting with small positions and raising your leverage progressively as you gain experience can be an excellent way to limit risk when you’re first getting started.
- Practice trading with demo trading — You can study the ins and outs of leveraged trading without risking any real money by using a so-called demo (also known as paper trading).
- Set clear objectives and keep risks to a minimum — Having a sound risk management strategy in place. Defined profit goals can go a long way toward preventing you from making rash decisions that result in losses.
- Divide your positions into separate portions — Another way to reduce risk is to divide your positions into parts. For example, instead of capturing your profits all at once when your single Take Profit is reached, you could set a series of Take Profit orders to capture your profits incrementally.
- Limit the duration of your transactions — Limit the amount of time you hold each position to reduce the danger of unanticipated price decreases and long-term market corrections.
FAQ: Frequently Asked Questions
How do I protect myself from crypto margin calls? Using protective stop orders to minimize losses from any equity positions and retaining sufficient cash and assets in the account is the greatest strategy for an investor to prevent margin calls.
Can I buy crypto on margin? With cryptocurrency margin trading, you can purchase crypto if you believe the price (and benefit from the increase) or sell it if you believe the price will fall (and profit from the price falling).
Which coin is best for margin trading? Litecoin (LTC), one of the largest and oldest altcoins, is most popular when it comes to margin trading.
Is margin trading the same as short selling? You borrow money from a broker to buy assets when you trade on margin. On the other hand, Short-selling entails borrowing tokens to sell them. Regardless, you are borrowing from the broker.
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