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The Most Simple Guide to Cryptocurrency Margin Trading

coinmonks profile image CoinMonks Originally published at Medium on ・6 min read

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

Margin trading in the crypto market poses higher risks than regular trading due to the volatility of cryptocurrencies. Similar to margin trading in traditional finance, cryptocurrency margin trading allows you to achieve higher potential profits by adding more risks to your trade. You do that by borrowing funds from a third party, in this case, a broker or other platforms, also known as margin lenders.

Crypto 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?

Understanding how crypto margin trading works can be overwhelming. To reiterate, we know that it allows traders to borrow capital in order to access increased buying power and open positions more extensive than their existing account balance. A trader gives the exchange platform some capital in exchange for another type of capital to trade with and make a profit from it.

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.

What are long and short positions?

So you’ve heard about open positions, but what are these exactly? Typically, in crypto margin trading, you’ll find two options: going short or going long. In long positions, the trader anticipates that the price of a crypto asset will increase. Going short is the opposite, with the trader opens a short position if they believe that the price of the said crypto asset will decrease — those who are going short usually traders seeking to profit from failing cryptos.

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.

The pros and cons of cryptocurrency margin trading

In a nutshell, margin trading in cryptocurrency could bring more substantial profits, diversifying your positions, access to more funds, and allows you to learn trading strategies. The profits may be more enormous due to the greater relative value of the trading positions. Besides, margin trading is good for diversification because traders can open several positions with a small amount of investment capital.

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.

Crypto margin trading tips

In the traditional financial world, margin trading is considered a high-risk investment strategy and not to be meddled with by inexperienced investors. Depending on the exchange you trade with, there are several tips or strategies that can be considered such as:

  • 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 on 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.

Crypto margin trading exchanges

It is not always necessary to trade on the highest leverage platform. There are other factors that you should consider before choosing to margin trade with an exchange, such as how high the interest rates are. Bitmex is a popular exchange that offers up to 100x leverage while offering varying interest rates from 3.65% per year or 0.01% per day, making it ideal for short-term positions.

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.

Also, read our FTX Crypto Exchange Review

Getting the funds from crypto lending

If you’re a trader and looking for more funding sources, an alternative worth looking into is crypto lending. Many crypto lending platforms such as Hodlnaut, BlockFi, or Celsius Network allow traders to borrow assets to arbitrage or margin trade. These platforms usually have customized terms and flexible loan-to-value. As always, read the fine prints before getting a loan. Once again, inexperienced traders might need to think twice before margin trading.

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

Author’s Bio: Sten Ivan is the Head of Growth at Hodlnaut, a Singapore-based fintech startup that enables users to earn favorable interest rates on their crypto assets.

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