What is margin trading in crypto?
Margin trading involves borrowing money to perform trades of a higher value — and taking a position on whether the value of a cryptocurrency will fall or rise.
Margin trading with cryptocurrency allows users to borrow money against their current funds to trade cryptocurrency on margin on an exchange.
The whole history of cryptocurrencies is inextricably linked to various kinds of speculation. Previously, the main part of them concerned participation in direct purchase/sale of real coins available to users through exchangers and exchanges of digital currencies. However, in recent times, a particular branch of crypto trading has become very popular — margin trading, which increasingly attracts novices with the opportunity to obtain fast super profits. However, not all of them are aware of the associated financial risks. And of course, there are some risks.
Therefore, it is recommended to pay attention to studying the basics and peculiarities of this type of trading before taking the first steps in marginal trading.
What is margin trading in the crypto industry?
The definition of “margin trading” is a type of speculation in the stock or crypto market, which consists of a trader using in his activity borrowed funds provided by an exchange or its users (in rare cases).
As in any other situation with obtaining credit loans, the user must provide collateral — in this case, to deposit an amount that guarantees the payment of debt obligations under the rules established by the platform. Own funds allocated for the opening of such transaction is a margin (hence the name of this type of speculation).
You can also find the term “trading with leverage,” which is an alternative designation for this type of trading because of the leverage — a multiplier (1–100x), which increases the available for the transaction user’s deposit at the expense of borrowed funds. Due to this possibility, the user can make a profit that is many times higher than that which would be present when speculating exclusively with own funds.
How does it work?
Positions that can be opened by a user on a crypto exchange offering this service are conditionally divided into two types:
- Long — when the user expects the growth in price of an asset;
- Short — when the user expects the price to go down.
In case the value of a cryptocurrency moves in the direction predicted by the trader, the income that he can get on the trade increases in proportion to the selected leverage. At the moment when such position is closed, the body of the collateral is returned to the creditor (exchange) along with commissions, and the balance of the profit received is credited to the user’s account.
For example, if you deposit $1000 to the exchange offering this service and open a Bitcoin long position with the leverage of 10x (1:10), the amount of the open position will be $10000 (the amount available to the trader has increased ten times). If the price rises by 1%, the user’s profit will be calculated from the total amount of the deal, i.e. it will make $100. Total at closing the position at this moment on the balance of the trader will be $1100 (net of commissions and other payments defined by its rules). If there were no leverage, the profit would be only $10.
In addition to commissions for opening/closing transactions, some platforms may have so-called financing rates, which are paid to each other by holders of long and short positions, depending on the number of open positions of each type.
Liquidation in margin trading
An important aspect of margin trading is that for any trade, a liquidation price is set — a price level calculated by the exchange, when reached, the position will be automatically closed with a full withdrawal of the user’s margin providing it. That is, if in the above example, a long trade was opened at a Bitcoin price of $10 000 and the liquidation price was set at $9500, the fall of the price to this mark would lead to the loss of $1000 contributed by the trader.
Of course, it is not necessary to use all the assets available on the balance to open deals with leverage. It would be more correct to allocate for opening a position only a part of the deposit, leaving an opportunity to average a position when the price moves in the opposite direction to the expected one. In this way, it is possible to move the liquidation price, which very often helps to wait for the drawdown and wait for the return of the asset price to the calculated range for profit.
In classic stock market leverage trading, the described position liquidation situation would be preceded by a margin call — a margin call requirement, which is a notification by the client’s broker that the margin allocated to him is insufficient and that there is a risk of forced closing of the position in case no additional funds are added. However, due to the rapid movement of prices in cryptocurrency pairs, there has been a shift in the concept — a margin call is now called the actual moment of liquidation. In the slang of cryptotraders, losing a position sounds like “catching a margin call.”
It is also worth paying attention to the fact that there are two main types of orders in cryptocurrency margin trading:
- Perpetual contracts, when the position is open until it is closed by the user or there is a liquidation;
- Futures contracts that are automatically closed when they expire.
The first option is the easiest and safest one, especially for beginners in margin trading in cryptocurrency. The second involves additional risk in the form of closing a trade when the price of an asset is in an unsuccessful range that implies a loss.
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Tips for margin trading
To become a professional in leveraged trading and minimize the risks of losing a deposit, you should always remember that margin trading in cryptocurrency sphere is a type of credit, which you will have to repay at least with the payment of established commissions, or with the loss of the body of the deposit. In this way, you can keep yourself from taking too much leverage or using the whole deposit to trade.
Rashly opening trades with the leverage by a user without serious level of trading skills will most likely lead to the loss of the deposit.
The choice of a cryptocurrency asset for margin trading should be made based on its volatility analysis. In order to open a trade, it is recommended to choose periods when there is minimal probability of drawdowns and pumps — sharp price jumps in different directions, with the help of which the market maker tries to knock out as many traders as possible. Ideal variants are trading with a leverage of pairs of an altcoin to Bitcoin, on the charts of which predictable recurring fractals can be traced.
An unsuccessful trade can be closed on your own, without waiting for liquidation. In this case, instead of the whole position, only part of the margin from the user’s balance is lost (professionals try to avoid more than 20% of losses). This can be done not only manually, but also by setting a “stop loss”, which is a type of order to limit trade risks, assuming automatic closing of the transaction when a certain price mark is reached.
On some platforms offering instruments for margin trading, there is a possibility to change the leverage “on the go,” which allows you to change the risk/profit ratio for an open position at a convenient moment. For example, if your trade has come out in not bad profit and movement of a price in the opposite direction is not expected, it is possible to increase a leverage (at presence on balance enough free funds for margin), thereby having changed the size of profit. But it should be remembered that when the leverage is changed “on the go” the liquidation price is also shifted — when increasing it is closer, when decreasing it is farther away. In the first case — the risk of “catching the margin call” increases. In the second case — there is an opportunity to delay the automatic closing of a position, on which the trader’s forecast has not come true.
Some exchanges practice charging commission fees on trades not only at the moment of their opening/closing but also in the process, at equal intervals. This, as well as the possible presence of the already mentioned system of mutual financing, should not be forgotten, holding positions with low leverage for a long time. Otherwise, the transaction costs may be disproportionate to the risk and profit received.
An open position that will soon be liquidated can always be averaged by buying additional contracts and thus saving it from closing. However, many professionals believe that this is the way to drain the deposit, as the trend can drag on and in the end, you just don’t have enough of your own funds to constantly push back liquidation.
When deciding to try yourself in margin trading, it is important to remember that unlike standard trading, where any unforeseen movement of the exchange rates can most often just be waited for, here long-term drawdown will actually mean a loss of deposit. Therefore, you should start such speculations only if you are able to seriously approach risk control and the formation of a trading strategy, and are morally prepared for potential losses in advance. Only with this approach you will be able to get a stable profit from trading with cryptocurrencies with leverage.
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