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What is Margin Trading Cryptocurrency? A Detailed Explanation
Last Update: 2024-11-16
Like many new cryptocurrency traders, you might be looking for ways to place bigger orders, but you just don’t have the capital. Margin trading cryptocurrency could be your best bet.
In short, it involves using money
that you borrow from a crypto exchange so you can “trade on the margin.”
In short, it involves using money
that you borrow from a crypto exchange so you can “trade on the margin.”
Margin trading allows you to make bigger profits with a
comparatively small investment.
Conversely, you can also incur big losses. Like many investments, finding out if margin trading is for you will come down to how you feel about its pros and cons after conducting thorough research.
comparatively small investment.
Conversely, you can also incur big losses. Like many investments, finding out if margin trading is for you will come down to how you feel about its pros and cons after conducting thorough research.
To succeed with this type of trading, you will need to know what you are doing and understand the rules of the game. You need to understand the risks.
We have prepared this brief article to help you get to grips with margin
trading.
We have prepared this brief article to help you get to grips with margin
trading.
After reading the article, you should be better
placed to make the right decisions about how you can integrate margin trading into your investment strategy.
placed to make the right decisions about how you can integrate margin trading into your investment strategy.
What Is Crypto Margin Trading?
In financial terms, margin is basically collateral for borrowing. Crypto exchanges like Binance lend traders
money to enable them to make bigger trades. When we speak of margin, it is the security that a trader must give to their crypto exchange to cover the risk the
trader poses as they buy and sell financial instruments with the money they
have borrowed.
money to enable them to make bigger trades. When we speak of margin, it is the security that a trader must give to their crypto exchange to cover the risk the
trader poses as they buy and sell financial instruments with the money they
have borrowed.
When you borrow funds from a crypto exchange to trade cryptos, you represent a credit risk to that exchange. When you “buy on margin,” you are trading using
a sum of money lent to you by the exchange for the chance to make bigger profits for you and the exchange.
a sum of money lent to you by the exchange for the chance to make bigger profits for you and the exchange.
Typically, before crypto traders can get a loan from a crypto exchange, they must put up an amount of their own of a roughly equal amount in order to qualify for
a loan. Your initial payment becomes the collateral for any future trades you make. How does this work? Well, if you open an account with
$1,000 of your own money, the crypto exchange will typically loan you an added
$1,000 with which you can start to trade. Different exchanges have different opening amounts.
a loan. Your initial payment becomes the collateral for any future trades you make. How does this work? Well, if you open an account with
$1,000 of your own money, the crypto exchange will typically loan you an added
$1,000 with which you can start to trade. Different exchanges have different opening amounts.
Your first $1,000 is put “on ice” in your account and stays there as collateral in case you make losses. But
why do it this way? Crypto
exchanges and, indeed, online brokers before them realized that if traders used
their own $1,000 and lost all that money, they would never return.
However, by lodging that $1,000 and trading with $1,000 of the house’s money,
traders can make bigger profits more quickly, increasing their chances of getting into the black and continuing to trade.
Margin Is Not a Free Lunch
why do it this way? Crypto
exchanges and, indeed, online brokers before them realized that if traders used
their own $1,000 and lost all that money, they would never return.
However, by lodging that $1,000 and trading with $1,000 of the house’s money,
traders can make bigger profits more quickly, increasing their chances of getting into the black and continuing to trade.
Margin Is Not a Free Lunch
If margin trading sounds like a freebie, it is not.
Traders must service the funds they borrow from the crypto exchange by paying regular interest and facilitation fees. The loan made to you by the exchange becomes
payable in full as soon as you make profits, and your crypto account balance
increases to a level where you can trade with your own money.
Traders must service the funds they borrow from the crypto exchange by paying regular interest and facilitation fees. The loan made to you by the exchange becomes
payable in full as soon as you make profits, and your crypto account balance
increases to a level where you can trade with your own money.
If you make a loss in the early stages, the crypto exchange can make a “margin call” at any time without negotiation, which is when they take the $1,000
collateral you gave them when you began. This margin call also allows the
exchange to take ownership of any securities in your account, such
as crypto that you bought but have not sold yet.
collateral you gave them when you began. This margin call also allows the
exchange to take ownership of any securities in your account, such
as crypto that you bought but have not sold yet.
Margin trading is not a passive exercise. The crypto
market swings quickly, so you will need to take your margin seriously and watch
your investments closely.
market swings quickly, so you will need to take your margin seriously and watch
your investments closely.
What Is an Exchange in the Cryptocurrency World?
In case it is not yet clear, acryptocurrency exchange is a digital marketplace that acts like a stockbroker
or an online broker. It provides you with a platform on which to buy and sell digital currencies, like Bitcoin, Tether and Ripple.
or an online broker. It provides you with a platform on which to buy and sell digital currencies, like Bitcoin, Tether and Ripple.
Well-known crypto exchanges include Kraken, Coinbase and Binance. A good exchange is one that is mature enough to have developed its tools and
services to make buying and selling cryptos easy and seamless. Like online brokers, crypto exchanges invest money and time to improve their interfaces and provide traders with features that differentiate them from rivals.
Naturally, exchanges charge fees for these services, and, as with all marketplaces, some exchanges are more expensive than others. Security is an important feature, too, as you
should feel as if your information and investments are protected. Just like
with online brokers, exchanges become more attractive as they improve their services, like supplying good withdrawal options and increasing
the number of supported currencies.
services to make buying and selling cryptos easy and seamless. Like online brokers, crypto exchanges invest money and time to improve their interfaces and provide traders with features that differentiate them from rivals.
Naturally, exchanges charge fees for these services, and, as with all marketplaces, some exchanges are more expensive than others. Security is an important feature, too, as you
should feel as if your information and investments are protected. Just like
with online brokers, exchanges become more attractive as they improve their services, like supplying good withdrawal options and increasing
the number of supported currencies.
Once you have chosen your exchange, you would need to open an account in the normal process that involves supplying your personal
details. Once your account is approved, you can fund it with the fiat currency in which the account is denominated.
details. Once your account is approved, you can fund it with the fiat currency in which the account is denominated.
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Practical Considerations When Trading Crypto On Margin
On most exchanges, you can borrow up to 50% of the purchase price of an instrument. Naturally, you can borrow less than 50% if you don’t need a loan of that size. Be sure to check what your exchange offers in this regard.
A crypto exchange will normally ask you to keep a prescribed minimum amount in your account, known as
the maintenance margin requirement. This is the initial investment we mentioned
earlier. The exchange will access this amount in the event it makes a margin
call. When the exchange needs its money back, it will “call in”
or liquidate your margin trade once you hit a price where you would start
losing the borrowed money. No exchange would allow you to trade indefinitely until you lose all the funds it advanced you, including your own.
the maintenance margin requirement. This is the initial investment we mentioned
earlier. The exchange will access this amount in the event it makes a margin
call. When the exchange needs its money back, it will “call in”
or liquidate your margin trade once you hit a price where you would start
losing the borrowed money. No exchange would allow you to trade indefinitely until you lose all the funds it advanced you, including your own.
To avoid a margin call,simply top up your account to a level of safety. Of course, it is not always this simple, as some traders run out of money. Be aware that as your debt level rises, your interest and fee liabilities rise, too. Crypto
exchanges offer leverage anywhere from 1:2 to 1:100. As it is an unregulated
space, some exchanges give traders leverage of up to 1:200. Losses
can stack up very quickly. That’s why margin trading is only recommended for controlled, short-term use where traders take advantage of crypto volatility.
exchanges offer leverage anywhere from 1:2 to 1:100. As it is an unregulated
space, some exchanges give traders leverage of up to 1:200. Losses
can stack up very quickly. That’s why margin trading is only recommended for controlled, short-term use where traders take advantage of crypto volatility.
What Buying Power Looks Like
Leveraging a purchase of crypto allows you to take advantage of
big market swings by magnifying your profits. Let’s work out an example of how this looks. If you were to start
with an amount of $1,000 in your account, this could be enough to cover a
maintenance margin requirement of $500, if that’s what your exchange needed. This would leave you with $500 available to trade.
big market swings by magnifying your profits. Let’s work out an example of how this looks. If you were to start
with an amount of $1,000 in your account, this could be enough to cover a
maintenance margin requirement of $500, if that’s what your exchange needed. This would leave you with $500 available to trade.
With $500 of your own money, a typical exchange could match that number by loaning you an added $500.
Now you have $500 frozen as collateral, and $1,000 to spend. You have doubled your effective spending power, despite $500 of your money being locked away.
Now you have $500 frozen as collateral, and $1,000 to spend. You have doubled your effective spending power, despite $500 of your money being locked away.
You need to know that once you start buying crypto, your account balance is not
static. If your account has
$1,000 worth of crypto, the value of the crypto could fluctuate following market volatility, dropping to $900 for example, as the market price
changes. This underscores the fact that trading crypto on margin is an active investment exercise, not a passive one.
static. If your account has
$1,000 worth of crypto, the value of the crypto could fluctuate following market volatility, dropping to $900 for example, as the market price
changes. This underscores the fact that trading crypto on margin is an active investment exercise, not a passive one.
How to Manage Risk with Margin Trading
As attractive as making large profits seems, you could just as easily
suffer heavy losses. This comes with the territory in the trading world, and
more so with crypto. However,
there are ways to be smart about the risks you take. Here are some ways to
manage your risk:
suffer heavy losses. This comes with the territory in the trading world, and
more so with crypto. However,
there are ways to be smart about the risks you take. Here are some ways to
manage your risk:
Have a Trading Plan
It’s vital to have a trading plan in the highly volatile crypto market. Working
to a plan will keep you consistent so that you can scale up to making profits
in a sustainable way. A good trading plan includes a comprehensive method of how to enter and exit positions. This must account for
entry and exit indicators, position sizing, and stop-loss placements.
to a plan will keep you consistent so that you can scale up to making profits
in a sustainable way. A good trading plan includes a comprehensive method of how to enter and exit positions. This must account for
entry and exit indicators, position sizing, and stop-loss placements.
We cannot stress enough the advantages of trading to a plan. Not only are you more relaxed in the act of trading, but you will make more rational and controlled decisions. It is essential to stick to your trading
strategy. You will inevitably suffer losses, all traders do. However, the key
is to know how to react when that happens. Will you abandon your plans when you
start to lose money? You could make impulsive and ill-advised trades
to try to claw back some ground.
strategy. You will inevitably suffer losses, all traders do. However, the key
is to know how to react when that happens. Will you abandon your plans when you
start to lose money? You could make impulsive and ill-advised trades
to try to claw back some ground.
Stop-loss Orders
Risk management includes doing things that will stop you from suffering
catastrophic losses. A stop-loss
is a type of order that allows you to put a cap on potential losses by naming a
price limit that triggers an automatic sell-off of your position.
This could look like buying a Bitcoin futures contract for the price of $500. In order to reduce the chances of a
loss, you could insert a stop-loss order at 20% below the purchase price, or
$400. If the price of Bitcoin plummets below $400, the stop-loss order is
activated. The exchange immediately sells the contract. Remember, the
trigger is for you to exit at $400, but by the time the exchange sells your
contract, it could have gone below $400. At least you will be within the range of your loss tolerance level.
catastrophic losses. A stop-loss
is a type of order that allows you to put a cap on potential losses by naming a
price limit that triggers an automatic sell-off of your position.
This could look like buying a Bitcoin futures contract for the price of $500. In order to reduce the chances of a
loss, you could insert a stop-loss order at 20% below the purchase price, or
$400. If the price of Bitcoin plummets below $400, the stop-loss order is
activated. The exchange immediately sells the contract. Remember, the
trigger is for you to exit at $400, but by the time the exchange sells your
contract, it could have gone below $400. At least you will be within the range of your loss tolerance level.
A stop-loss just allows you to apply the brakes as you approach a certain level of loss. You don’t have to
think about it or get caught up in the emotion of waiting for the
price to rise again.
think about it or get caught up in the emotion of waiting for the
price to rise again.
Don’t Risk More Than You Can Lose
It is one of the fundamentals of
trading. Do not trade with money you cannot afford to lose.
Invest with excess savings or a predetermined amount with which you are
comfortable never seeing again. In volatile markets like crypto, you can lose
money quickly, so you need to ringfence
the amounts you are comfortable with losing and don’t dip into money you need.
trading. Do not trade with money you cannot afford to lose.
Invest with excess savings or a predetermined amount with which you are
comfortable never seeing again. In volatile markets like crypto, you can lose
money quickly, so you need to ringfence
the amounts you are comfortable with losing and don’t dip into money you need.
Take Profit When You Can
When the going is good, make a habit of taking profit. A take-profit order lies on the opposite side of a stop-loss. You can set your account to close its position when the profit on a contract hits a
specific amount. This stops you from becoming greedy and gives
you the chance to walk away with profits before the price changes through
unexpected swings.
specific amount. This stops you from becoming greedy and gives
you the chance to walk away with profits before the price changes through
unexpected swings.
The Pros and Cons of Margin Trading Cryptocurrencies
There are pros and cons to trading cryptos on margin. It is important to understand this before you embark on your
journey.
journey.
Pros
- You can make large profits.
- You can diversify your portfolio through increased buying power.
- You can trade with limited funds.
- It teaches you discipline and risk management.
Cons
- You can lose a lot of money.
- It is always risky.
- You can lose money quickly.
- New traders face a steep learning curve.
Even though crypto trading is still an unregulated area, many exchanges are pre-emptively adopting responsible behavior by
providing traders with vast amounts of educational material. Most good
exchanges have invested in detailed educational materials that allow new
traders to always make informed decisions as they come to learn the
pros and cons of margin trading cryptocurrencies.
providing traders with vast amounts of educational material. Most good
exchanges have invested in detailed educational materials that allow new
traders to always make informed decisions as they come to learn the
pros and cons of margin trading cryptocurrencies.
Strategies for Trading Cryptos on the Margin
Now that you know the fundamentals of margin trading, it is always good to understand what strategies you can employ to
start margin and leverage trading cryptocurrency. Here are some strategies to
consider:
start margin and leverage trading cryptocurrency. Here are some strategies to
consider:
Slowly increase your trade sizes: It makes sense to start
slowly before taking a chance with bigger trades. Starting small and navigating a few successful
trades gives you confidence to increase the trade sizes.
slowly before taking a chance with bigger trades. Starting small and navigating a few successful
trades gives you confidence to increase the trade sizes.
Improve your skills through demo trading: In the same way that online brokers allow you to practice risk free, demo trading is available on most good exchanges.
Split your positions: It is often a good strategy to divide
your positions smartly. This could look like managing your take-profit orders and stop-loss orders in
tandem, so you are never too exposed or too greedy.
Limit how long your positions stay open: Don’t hold on to positions for too long,
especially in the crypto space.
Split your positions: It is often a good strategy to divide
your positions smartly. This could look like managing your take-profit orders and stop-loss orders in
tandem, so you are never too exposed or too greedy.
Limit how long your positions stay open: Don’t hold on to positions for too long,
especially in the crypto space.
Keep a set limit of capital per trade: It is always good advice to not risk more than 5% of your capital on a single trade,
no matter how attractive it seems. This is not to say you should always invest 5%, you can invest as little as 1-2% of your capital on
a given trade, especially as you are getting to grips with the market.
no matter how attractive it seems. This is not to say you should always invest 5%, you can invest as little as 1-2% of your capital on
a given trade, especially as you are getting to grips with the market.
Conclusion
Margin trading cryptos is a very exciting space. Crypto is a very
dynamic market with daily and even hourly swings and counter swings. It can be exhilarating to go on a string of wins, but remember that trading on margin can lead to devastating losses.
dynamic market with daily and even hourly swings and counter swings. It can be exhilarating to go on a string of wins, but remember that trading on margin can lead to devastating losses.
The market can be intimidating for new traders, but with a focus on self-education and research, anyone can learn how to navigate the market. Money management and discipline are going to be keystone traits if you are to thrive in this area.
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FAQ
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Crypto margin trading platforms
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