The Brief Guide to Cryptocurrency Margin Trading

In finance, margin trading uses borrowed money from a broker to trade a financial asset, which forms the collateral for the broker’s loan. Margin is the funds borrowed from a brokerage firm to purchase a type of investment. To buy on margin refers to using the money borrowed from a broker to purchase securities. Essentially, margin trading is a way to increase more profits by adding more risks to your trades. Trading on a margin is risky because they can both bring loss or success to your investment portfolio.

Crypto margin trading explained

Cryptocurrency margin traders need to be more cautious, especially those new to trading or cryptocurrencies. You might get around it faster if you have prior knowledge of hedging and risk management strategies. Even if you have substantial knowledge in identifying market trends and charts, knowing the entry and exit points still won’t eliminate margin trading risks. For what it’s worth, crypto margin trading does bring new opportunities to traders. Let’s see how it works.

How does it work?

Fundamentally it’s quite simple; a trader must provide an initial deposit to open a position; this is what we called an initial margin. The trader must hold a certain amount of capital in their account to maintain the position. In cryptocurrency exchange or lending platforms, the amount of capital you deposit is held as collateral by the platform. The amount you’re able to leverage for margin trading depends on the rules imposed by the platform you trade with and the initial deposit.

There are varying degrees of leverage imposed by different crypto exchanges. Some exchanges will require 100x leverage, meaning traders can open a position 100 times the value of their initial deposit. There are also other exchanges that limit the leverage to 20x or 50x.

What are long and short positions?

Source: Investor Software

When margin trading, the exchange you trade on will hold your initial deposits as collateral. The exchange will release the crypto you deposited and the profits if you successfully close a position at a profit; likewise, if you realize a loss when margin trading, the exchange will liquidate your position and close your trade.

Margin calls and liquidation

This is what we call a margin call. It occurs when the value of the crypto asset in a margin trade falls below a certain point. The exchange will notify the trader to provide additional funds to mitigate the risk. In the case of the margin level of a position becomes too risky, the exchange will liquidate. Liquidation happens when an exchange funding the trader automatically closes a position to minimize further damage. By doing so, only what the trader deposited to open the position is lost and not others.

The pros and cons of cryptocurrency margin trading

However, crypto margin trading’s immediate disadvantages are higher risks, significant losses, and extremely volatile. Unlike regular trading, margin trading could result in losses that exceed the trader’s initial investment; even a small drop in the market price may cause significant losses.

Cryptocurrency margin trading tips

  • Start small and increase progressively. This is a safe bet especially if you’re new to margin trading. It’s always recommended to begin with a smaller position and lower collateral.
  • Set your goals. It’s essential to have a clear path to profit strategy and follow the plan. Have an exit goal and stop-loss levels, that is, the price of your asset reaches a certain level.
  • Check the fees and interest. Crypto exchanges that support margin trading will not do it for free. As you open a leveraged position, there will be interest in the capital you borrow as well as other fees as well.
  • Don’t overlook the external factors. There could be regulatory changes, major crypto wallet movements, or even exchange hacks, that could create unexpected price changes.

Cryptocurrency margin trading exchanges

CEX.io allows both crypto margin trading and fiat deposits, that way you can withdraw from an account via wire transfer or paying using credit cards. Other popular options for exchanges include PrimeXBT, BaseFEX, and ByBit.

Getting the funds from crypto lending

All in all, and despite the risks, cryptocurrency margin trading is a fascinating avenue for traders, individual investors, and crypto enthusiasts, in general, to aid in profitability and portfolio diversification.

This article is originally published at Coinmonks.

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Originally republished at https://blog.hodlnaut.com on November 12, 2020.

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