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A simple guide to margin trading cryptocurrency
Read our beginner’s guide to margin trading bitcoin and other cryptocurrencies.
If you want to trade cryptocurrencies but you only have a limited amount of capital to work with, you may want to consider a tool known as margin trading. By borrowing money from a cryptocurrency exchange or broker to increase your buying power, margin trading offers the potential for greater profits.
Of course, it also comes with a high level of risk attached, so let’s take a closer look at the key margin trading facts you need to understand before opening a position.
What is cryptocurrency margin trading?
The simplest explanation of margin trading is that you are trading cryptocurrencies using borrowed funds. It involves borrowing capital at relatively high interest rates from a cryptocurrency exchange so you can access increased leverage. This allows you to access increased profits if the market moves in your favor, but also comes with the risk of increased losses.
As a very basic example, let’s say you want to buy a cryptocurrency that you’re confident will increase in price. However, you only have $1,000 to spend in your trading account, and you know that if you had more capital to work with, you could enjoy a bigger profit.
With margin trading, you borrow against the funds you already have in your account. So if you borrowed an extra $1,000 from the exchange, you would then have a total of $2,000 to put towards your purchase, potentially doubling your profits if the price moves in your favor.
How does it work?
To understand margin trading, you’ll first need to understand the concept of leverage. Leverage refers to the increased buying power you have when you trade cryptocurrencies on margin. The maximum leverage you can access differs between exchange platforms, and you’ll typically see it expressed as a ratio, for example 5:1 or 20:1.
For example, if a platform offered leverage of 2:1, you could open a position worth twice the value of your trading account — in other words, if you have $10,000 in your account, you can place a trade worth up to $20,000. If the maximum leverage was 20:1, you could open a position worth 20 times your account balance.
As a result, if the market moves in your favor, your gains will be magnified by the amount of leverage selected. Conversely, losses are also magnified if the market moves against you.
Margin vs. leverage — what’s the difference?
If you’ve been researching cryptocurrency trading, you may have come across the terms margin and leverage used more or less interchangeably to refer to the same thing — so what do they both mean?
Margin refers to the loan your crypto exchange offers you to place larger trades. This loan is collateralized by the funds in your account and you will need to pay it back with interest.
Traders use margin to create leverage, which is the increased buying power that allows you to open larger positions than you would be able to if you could only use the funds in your account. Leverage is expressed as a ratio, such as 2:1 or 5:1.
How to margin trade — going long vs. going short
There are two options when opening a margin trade:
- Going long. Also referred to as opening or entering a long position, this is when you buy a cryptocurrency in the belief that its price will go up. The aim is to use leverage to benefit from increased gains if the price rises as you predict.
- Going short. Also referred to as opening or entering a short position, this involves selling a cryptocurrency to bet that its price will go down. The aim is to then purchase that crypto back once its price has dropped and profit from the spread.
How is cryptocurrency margin trading different than regular trading?
The traditional method of trading crypto is to buy and sell digital currencies on an exchange using your own funds. You buy coins or tokens at the current price and then hold them until the price (hopefully) rises, either over the short- or long-term, so you can sell them for a profit.
The key difference with margin trading is that you borrow money from an exchange to increase your buying power, providing the potential to access higher profits.
What are the benefits of cryptocurrency margin trading?
The main advantage of margin trading is the potential for larger gains. If the market moves as you expect and your price prediction is correct, your profits will be increased — for example, if using leverage of 2:1, you’ll receive double the gains. If you’re an experienced trader with an in-depth knowledge of cryptocurrency markets and risk management, margin trading can be an effective trading tool to help you build a bigger balance.
What are the risks?
While margin trading can amplify your gains, it can also amplify your losses. This is the biggest risk you need to be aware of before you even consider trading on margin since it’s possible to lose your entire balance.
Exchanges always require traders to maintain a minimum level of equity in their account, for example 30% of the open position. If your balance falls below this minimum margin requirement, for example if the market moves in the opposite direction than the one you predicted, you’ll have to add more funds to your account to avoid liquidation — this is known as a margin call. If you can’t provide the necessary funds to keep an order open, it will be closed automatically.
It’s also worth pointing out that any money you borrow to fund a margin trade doesn’t come free. You’ll need to pay interest on the amount you borrow as well as repay the loan amount. You’ll also need to pay attention to the platform’s trading fees as well. It’s also important to be aware that you’re required to hold a certain percentage of the value of your position on the exchange at all times in order for that position to remain open. If you experience a loss on your position that exceeds a certain limit, known as the liquidation price, your order will be automatically closed.
Gains and losses are magnifiedBefore placing a margin trade, make sure you’re aware that leveraged trading magnifies both profits and losses. While you’ll enjoy greater gains if the market moves in your favor, you’ll also suffer larger losses if the price moves in the opposite direction than your prediction. As a result, margin trading is not suitable for anyone new to trading or to cryptocurrency.
It’s also important to be aware that you’re required to hold a certain percentage of the value of your position on the exchange at all times in order for that position to remain open. If you experience a loss on your position that exceeds a certain limit, known as the liquidation price, your order will be automatically closed.
Margin trading tips
Keep the following tips in mind if trading with a margin account:
- Reconsider if you’re an inexperienced trader. If you’re new to trading or new to the world of cryptocurrency as a whole, margin trading probably isn’t for you. It’s a highly risky approach that’s best suited to experienced traders.
- Start slowly. To minimize risks, it’s often a good idea for new margin traders to start by using a low level of leverage and to avoid using all funds in one transaction.
- Manage risks. Utilizing stop-loss and take-profit orders allows you to set clear limits for closing positions and can help prevent problems.
- Research the exchange’s criteria. Some exchanges only offer margin trading to customers who meet a range of criteria, such as ID verification or being able to access a specified amount of capital. Remember to research any qualification criteria that may apply before choosing an exchange.
If you’re an experienced trader and you’d like to margin trade cryptocurrency, start by doing plenty of research. Compare the fees and features as well as the pros and cons of various margin trading platforms to find the one that’s right for your needs.
Disclosure: At the time of writing, the author holds IOTA and XLM.
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