Understanding what margin trading is in crypto is crucial for enthusiasts seeking to navigate this volatile market.
Cryptocurrency margin trading is one of the most popular trading methods among crypto enthusiasts. Why? Because it enables traders to buy crypto assets using borrowed funds. This means that they’ll be able to own a large number of cryptocurrencies for a small amount of money. Although this method can be very profitable, it also comes with challenges.
On that note, we created a guide in which we’ll explain what is margin trading, why is it so popular, how it works, and what are its main benefits and risks.
What Is Margin Trading?
Margin trading is an investing method that involves borrowing funds from a crypto exchange. It enables traders to increase their buying power without investing large amounts of money.
For example: if you want to buy 1 BTC, but you only have 0.1 BTC in your wallet, you can increase your buying power by borrowing 0.9 BTC from a crypto exchange that offers margin trading. Crypto margin trading exchanges will offer different margin levels, which can go up to 100x.
Why Is Margin Trading So Popular?
Margin trading cryptocurrency is very popular for several reasons. First of all, it enables investors to increase their profits and buying power. Secondly, margin trading enables investors to profit from changes in cryptocurrency prices.
For example, they can sell their cryptocurrencies at a higher price and buy them back at a lower price to return the funds they borrowed. This is called short selling.
Margin trading is also popular because it offers access to different trading pairs. This allows investors to speculate on the prices of both pairs, instead of a single cryptocurrency. And finally, margin trading enables investors to use multiple assets as their collateral. This makes margin trading more flexible compared to other trading strategies.
How Does Margin Trading Work in Crypto?
Crypto or Bitcoin margin trading refers to borrowing money from a crypto exchange to make larger trades. That said, investors can choose between two positions – long and short. Long positions refer to profiting from rising crypto prices, while short positions refer to profiting from price drops.
Investors will have to make a deposit to open the desired position. This is called the initial margin. They will also have to add funds to their account to maintain their position. This is called the maintenance margin.
Each crypto exchange will offer different leverage levels that can vary from 2x to 100x. Crypto exchanges will also use borrowed funds as collateral. Borrowed funds come with an interest rate that will depend on the borrowed amount.
To conduct a margin trade, you’ll have to do the following:
- Create an account on crypto exchanges that provide margin trading
- Make a deposit
- In the margin market tab, choose the asset you’d like to invest in
- Enter the desired amount and choose your leverage
- Choose your position by tapping the Long or Short button
- Close your position by tapping the Close button
Types of Margin
There are two types of margin trading — cross and isolated. The former is more suitable for advanced traders, while the latter will be more suitable for beginner traders.
Cross-margin trading refers to using all available account balances as collateral for open positions. This enables traders to open larger positions with a smaller deposit. Moreover, both long and short positions will be based on market trends. The biggest downside of cross-margin trading is that the investors may lose their entire balance if there are unfavorable market movements. This makes it unsuitable for beginners.
When it comes to isolated margin trading, investors will be able to decide what their collateral for a specific position will be — after opening a position, they will have to set a margin equal to the initial margin of their position. If there is an unrealized profit on a certain position, it will not affect their other positions.
Furthermore, the crypto exchange will increase the margin of their position automatically to prevent liquidation. Isolated margin trades are more suitable for beginners. Why? Because potential losses will be limited to the margin of the position, not the entire balance.
During your trades, you’ll also come upon the term free margin. What is free margin in trading? The free margin represents the amount of money available for opening trading positions. Free margin can also be cashed out, while the same is not the case with funds that are held as margin.
What Are Margin Calls
A margin call occurs when the exchange asks traders to deposit additional funds into their accounts to avoid liquidation. These calls are issued when the value of the margin falls below the amount of deposited collateral — when traders are no longer able to maintain their maintenance margin.
If traders fail to deposit additional funds, exchanges will sell their collateral and close their positions. This is called liquidation.
Investors can avoid margin calls by:
- Diversifying their portfolio
- Having an emergency fund on the side
- Monitoring their trading activities
- Using stop-loss orders and setting low leverage
Margin Trading vs. Leverage Trading
The term margin refers to initial capital that is deposited as collateral. On the other hand, leverage describes borrowed capital. That said, leverage and margins will be expressed differently. The former will be displayed as an X, for example, 25x, while the latter will be displayed as a ratio, for example, 25:1.
What Are the Pros and Cons of Margin Trading Cryptocurrency?
Now that you know how to trade crypto with leverage, here are the main benefits and challenges of margin trading.
- You can increase your buying power: Margin trading will help you increase your buying power without investing much money.
- You will be able to profit from both rising and falling prices: You’ll be able to open both long and short positions.
- Flexibility: Unlike traditional loans, margin accounts don’t have fixed repayment schedules. You only need to be careful not to go below the maintenance margin requirements.
- Diversity: Margin trading will help you diversify your portfolio because you can trade different crypto pairs.
- Higher potential losses: Margin trading can cause higher losses. This is especially the case if you engage in cross-margin trading.
- Margin calls: If you fail to maintain your position, the exchanges may sell your collateral.
- Fees: You’ll have to pay fixed fees to open a position. However, these fees are usually pretty low.
So, what is margin trading in crypto?
Crypto margin trading is an ideal strategy for professional traders who want to generate higher returns. On that note, traders will be able to take advantage of both decreasing and increasing crypto prices by opening a long or short position.
However, margin trading comes with certain risks, such as margin calls and higher potential losses. To avoid potential risks, you can open your position using lower leverage. You can also take advantage of stop-loss orders.