The Capital
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The Capital

Margin Trading

By 3Сommas Blog on The Capital

Introduction

Big money comes with significant risks.

Margin trading is one of the riskiest, yet profitable strategies on the market. Margin trading has caused bitcoin and other digital assets to become popular tools for many traders. Volatility demonstrated by the cryptocurrencies market allows traders to make efficient use of margin trading and profit during both bear and bull markets. This article elaborates on margin trading, as well as the main advantages and disadvantages of working with this tool.

It is relatively easy to trade with leverage on a fundamental level. This trading instrument allows you to increase your trading position considerably, yet it is easy to lose it as well.

With the help of margin trading, users with modest capital can trade large volumes by borrowing funds from an exchange. The best thing about margin trading is that the user can make profits not only during bull markets but also during the bear ones. Thus, with a slight change in the price of the asset, there is an opportunity to make significant profits.

Let’s assume that you can make a transaction with 10 bitcoins while having only 0.1 bitcoins on your balance. Sounds unrealistic, doesn’t it? Well, it is real, but there’s a catch.

Most cryptocurrency exchanges offer the possibility of trading with leverage, which exceeds the balance by up to 100 times. This means that a trader can open a position 100 times larger than his deposit. Exchanges allow this, but a trader must know two things: the liquidation price and the commission cost.

How much can I lose if I trade cryptocurrencies with leverage?

When you trade with leverage, there is a liquidation price. It means that when an asset reaches this price, you lose the money you allocated initially to trading. To avoid liquidation, you should use a useful feature called stop-loss. When you enter a trade, you can set a stop-loss and thus avoid reaching the Liquidation Price. Of course, when the stop-loss price is reached, the trade ends, and you end up losing some of the money you’ve allocated. But it also allows you to save some money if the price does not follow your expectations.

What are the fees charged for margin trading?

Margin trading fees can vary from exchange to exchange. Trading fees depend on the selected leverage. If you are trading 1 bitcoin with 10x leverage, you are actually trading 10 bitcoins and end up paying the corresponding commissions. Sometimes trading fees also depend on the order type: Limit, Market, Conditional. You will need to check the commissions with the exchange you plan to trade on.

As in any other market, long positions are prioritized, because, apart from the profit in the form of additional coins, the value of each coin to the fiat currencies (RUB, USD, EUR) increases as well.

For example, if the price of BTC is $8000, assuming that the price will decrease by 20% to $6,400. It is possible to open a short position of 1 BTC with 10x leverage, in case there is a 20% drop and you’ve taken advantage of a 10x leverage, the profit will be equal to 200% or 2 BTC. Once the position is closed, the trader will own 3 BTC, with 1 BTC at $6,400. As the asset is 20% down, it will equal to $19,200 instead of the original $8,000.

But if you open a long position (long) with a 20% target to $9,600, with a 10x leverage as well, you will have 3 BTCs on your balance after the position is closed and the total amount of Fiat will equal to $28,800, instead of $9600 (if no trade was made). However, the profit in terms of BTC is identical.

In case a trader opens a short position with 10x leverage, the liquidation price will be at $8700-$8800. When the asset’s value reaches the liquidation price, the exchange reserves the right to close the position automatically.

The higher the leverage, the closer the liquidation price is. To calculate the percentage of liquidation price, simply divide 100 by the leverage level. For example, a position with 1:25 leverage requires only a 4% move (100 divided by 25) to get liquidated. Since the market is very volatile, 4% can be achieved quickly, but this same movement in the expected direction can bring 100% profit. The same applies to the 125 leverage (100 divided by 125), which results in 0.8% for the liquidation to be executed.

Margin trading also provides an opportunity to hedge your cryptocurrency portfolio. For example, if there are 5BTC in a crypto portfolio and the trader wishes to hedge against the risk of a possible drop of bitcoin, he can open a short position with 10x leverage, which is equivalent to 40% of his bitcoin portfolio.

Just like regular trading, margin trading is very risky and has its pros and cons. We will list some of them so that you can decide whether it is the right tool for you.

Advantages of Margin Trading

1. Increase in purchasing power

The most significant advantage of cryptocurrency margin trading is the control of a much larger position through borrowing from the exchange. And most importantly, there is no need to repay the funds you borrowed. If your position equals to 1 BTC and you use 10x leverage, you are actually trading with 10 BTC. If you are doing it right, then everything is fine. If you are liquidated, you lose 1 BTC instead of 10.

2. Market volatility

The cryptocurrency market is rapidly developing and possesses a high level of liquidity. Market volatility combined with higher available leverage can provide higher returns than in some other markets where traders have to wait for a long-term asset growth and return on the traded assets. Of course, it is possible to lose capital more quickly, but we will consider this issue a little later in the “Disadvantages” section.

3. Profit during a bear market

Do you want to make money during the Bitcoin bear market? You can. A short bitcoin position is basically a bet on the expected price decline. Technically, short positions work by first selling the underlying asset, bitcoin, in this case, and then buying it back. You do not need to worry about the technicalities; stock exchanges do this process automatically.

4. Higher leverage increases your profits

Access to leverage can make a significant difference for both small and large trading volumes. The availability of leverage resources in the cryptocurrency market is higher than in most other markets. Depending on the platform, you can access margin trading that allows you to use 100x or even higher leverage.

5. Exponential growth

Before the launch of margin trading, it was difficult for traders with moderate position sizes to quickly multiply their assets, as they could only open positions equal to their deposit. Cryptocurrency margin trading allows for trading the position, exceeding your initial capital by tens or even hundreds of times. Efficient trading can help increase the small balance and turn it into an acceptable position size.

Shortcomings of margin trading

1. Cryptocurrency market volatility

All markets can be volatile at certain times, and this applies to the cryptocurrency market as well. While market volatility can bring you significant profits, it can also lead to huge losses. So, be alert and always stick to a mapped out trading plan.

2. High risks

This is one of the most prominent disadvantages of using borrowed funds for cryptocurrency trading. Holding a large position may lead to profits, but can cause losses as well, as you can lose everything you bid. Due to the manipulative nature of the cryptocurrency market, the chances of losing the deposit are high. However, if you use stop-loss wisely, the risk of being liquidated is reduced.

3. Traders with small positions may face manipulation.

In the unregulated market, it is common for the price to face significant rises and drops, resulting in large candle wicks on the chart. Often, when the number of short or long positions prevails over one side, it means that someone can easily make money. Such manipulations can be executed by creating the opposite price movement, forcing these positions to liquidate, which eventually causes even greater panic and liquidation on the stock exchanges. The following image describes the classic bitcoin price manipulations.

4. Liquidation

Think of margin trading as of a bet. You don’t actually trade as you don’t sell or buy the coins. You bet that the value of the coin will increase (long position) or decrease (short position). There are three main differences between betting and margin trading: 1) you can trade using leverage, 2) you can set a stop-loss, and 3) you do not need to count the money traded as part of your winnings. If you bet $100 and receive $200, you will have $200. If you trade $100 and make a profit of $200, you will have $300. If you do not have a stop-loss and the position is liquidated, you only lose the amount you traded with. The same thing happens when you place a bet.

5. High commissions fees

Commissions should also be taken into account. The higher the leverage, the higher the commissions are. If you trade 1 BTC with 10x leverage, you are actually trading 10 BTC and paying commissions accordingly. But that’s fine as you don’t need to pay back the funds you borrowed if you lose. You only pay the amount you’re mortgaging. The majority of cryptocurrency exchanges’ earnings come from commissions; everyone should know that.

Conclusion

First of all, a trader should control his emotions while taking large positions. The best strategy is to ignore the total amount that he has to trade as it includes leverage. It is necessary to focus on the original position and not to give in to emotions. Fear is one of the two most frequently discussed emotions in trading (the second one is greed). Fear manifests itself in trading in different ways, and it can be the cause of many trading mistakes; therefore it is necessary to set the stop-loss. Doing so considerably reduces stress. Having made a deal, and if it doesn’t go as expected, the trader only loses a part of his position.

Margin trading is very useful in the cryptocurrency field and can be profitable if used correctly. It is a superb tool for people who wish to buy more assets using moderate capital and those who possess a limited amount of time. However, before you get started, it is crucial to study the trading instrument thoroughly and practice with small deposits to master all the possibilities of margin trading.

Visit our website http://3commas.io/

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3Сommas Blog

3Сommas Blog

Trading blog. Tools, bots, strategies.