There are few terminologies as common as ‘margin’ and ‘margin trading’ in trading circles. Margin trading is quite technical and requires a high level of understanding to pull off successfully. But fear not, for this post is here to guide you.
Simply put, margin trading is the type of trading that is funded by third parties. In order words, margin traders “borrow” money from third parties to trade with larger funds for larger rewards. These third parties are usually brokers in forex, and exchanges or other traders in cryptocurrency.
The margin is the money the trader owns himself. It is the money the trader is required to deposit and lock in his account to maintain his trade, almost like collateral. The size of the margin is determined by how much leverage the trader chooses to trade with.
Leverage is the tool used to amplify trading funds. The leverage selected, coupled with the margin, determines how much a trader is borrowing to trade with. Different markets and exchanges have different rules guiding their leverage system. For example, the forex market typically offers leverage between 50:1 and 500:1; while the cryptocurrency market offers between 2:1 and 100:1 mostly. Leverage in cryptocurrency trading is denoted in ‘x’, and you will see it appear quite often on a crypto exchange. 5x means you are trading with 5 times leverage, 10x means with 10 times leverage, and so on. The amplification of funds also means a corresponding increase in profits, which makes margin trading extremely attractive.
To ensure your borrowed funds can be accounted for, liquidation is introduced into the mix. This is the event in which the trade is automatically closed and the trader loses all of his margin. That means that the trade has reached the limit where the trader’s deposit has been used up. The liquidation price is calculated using your leverage, maintenance margin, and entry price; and is calculated by the exchange’s system once you input the values of your trade. Liquidation can be avoided by placing stop- loss or manually exiting the trade before hitting the liquidation price, or a trader could shift the liquidation price back by adding more margin to keep the trade running. This is the dark side of margin trading. The risk is very high, and the trader puts himself at the risk of losing all of his margin. The same volatility that could drive up his profits if going the right way could also decimate his account margin as easily. Thus, margin trading is only advisable for experts.
Not to be the killjoy, it is noteworthy that users can also earn from margin trading without actually trading. This is via margin funding, where users can choose to lock their funds for other users to borrow and trade with. Think of it like being a loan shark, a digital loan shark; or even more like operating a fixed deposit account with a bank. However, there are requirements varying from exchange to exchange a user has to meet to be eligible for margin funding. Also, not every exchange has margin funding on offer.
Conclusively, margin trading is a world taking risk and reward to a whole new level. It really is not advisable for beginners, but it sure is worth exploring once the trader possesses a requisite quality of trading expertise.