What is Margin Trading?
Margin trading is when loans are taken from a broker to enable the borrower to buy items he cannot
afford.
For example, if a person wants to purchase a $50,000 propriety, but has only $10,000, he will go to a
bank and apply for a loan. After his credentials are verified, his loan may or may not be approved by
the bank. If the land’s price increases, the borrower will gain profits from his investment.
Crypto Margin Trading
Crypto margin trading is a similar process to bank loans or mortgages, but instead of real estate, they
use digital assets. You first have to access a cryptocurrency exchange which supports margin
trading, then open a position with leverage and then make the loan.
The capital which is used for the loan is from an operating account, the broker not using any
customer funds. but there are some exceptions which allow the direct borrowing among users.
The loaned money can be leveraged in any cryptocurrency which is available and which has potential
of increasing in value.
What Are Long and Short Positions?
You might have heard of taking short or long positions when talking of margin trading, and these
terms show if a trader believes a cryptocurrency has the potential of growing or dropping in value.
If a trader takes a long position this means that he believes the crypto he just purchased has the potential of increasing its value over time – and by leveraging the sum, this can either multiply his gains- or if he’s wrong- his losses.
When it comes to a short position, the trader can use this approach when he thinks his crypto will go
through a drop in price. For example, a trader might buy and then sell his crypto at its current price,
and then when it drops, rebuy it at a lower price to generate a profit.
Leverage Ratio
Leverage represents how much money an investor can borrow from the exchange or broker. The
amount one can leverage is represented in ratios (1:2, 1:3, 1:3, etc.). In traditional trading, the
leverage amount is at a 1:1 ratio.
However, cryptocurrency exchanges usually offer a low amount of leverage because unlike the Forex
market, the crypto market is prone to high volatility. Cryptocurrency lending doesn’t feature
leveraging rations of 1:500.
Margin Trading Risks
Cryptocurrency margin trading incurs rather high-interest rates and fees, so it’s best that novice
traders take on a cautious approach. Some might want to profit of huge discrepancies offered by
market volatility, but there always comes a risk when trading with leverages.
- Equity threshold. To be able to get into margin trading with cryptos, you must have an equity
level that is situated over a certain threshold (the average amount found on exchanges being
around 30 percent). If your account’s equity goes below this percentage, the trader cannot
open a position if he doesn’t make an additional deposit to reach his equity limit.
- High-interest rates. The interest rates imposed by crypto exchanges for margin trading are
rather high, especially when long-term investments are involved. Because of this, it is
recommended to close the position if the crypto hasn’t experienced its predicted price
increase. This is due to the interest rate may which constantly increases and may end up
taking a good chunk out of your profit.
- Huge losses. The crypto market is prone to high fluctuations, and because of this, higher
amounts of leverage are not implemented by brokers. Opening a position with a larger ratio
can generate huge profits, but on the flip side you may end up losing more than you are able
to pay for.
- Forced Liquidation. Forced liquidation is the process of the broker closing all you margin
positions in order to assure that you will not avoid paying the initial funds that you
borrowed. It is important to verify positions and reduce their size to limit losses and avoid
the unfortunate scenario of forced liquidation.
Margin Trading Exchange
There are several cryptocurrency exchanges which support the feature of leverage trading. The
procedure for opening a margin position is usually the same regardless of the exchange you select.
Some might have different fees, initial equities, leverage amount/ratio, and supported cryptos.
OKEx and Kraken are among the exchanges that have implemented this feature, but other exchanges
like Binance do not currently offer margin trading of any kind. Huobi made available margin trading
at the beginning of this year, and traders can also use HitBTC, Bitfinex, and Bithumb to take advantage of this feature.
Final words
Margin trading can be a powerful tool for cryptocurrency investors, but it can also bring crippling
losses due to trading fees, high interest rates, and extreme market volatility.
Featured image: YouTube
