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Margin trading crypto: a comprehensive guide to leveraged trading

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Introduction to margin trading in crypto

You've probably heard the term margin trading at least once in your life. We'd actually be surprised if you answered "no"! After all, this type of trading is one of the oldest and remains the most common one. Like all successful ventures, it evolved and kept up with the times to grow into what we're discussing today – cryptocurrency margin trading.

What is margin trading?

Margin trading is one of many trading methods. In this case, a trader uses a credit provided by a broker to purchase a transaction.

Its basic essence remains the same: profiting from price fluctuations of digital assets. In the context of the crypto market, this broker would be one of the crypto exchanges. This is needed to increase the size of their order and, consequently, the potential profit. Or loss. It depends on luck.

The growth of margin trading in crypto markets

The first significant milestone was recorded in the 18th century when margin trading became widely used on the London Stock Exchange and soon became available to a wider audience.

In traditional financial institutions, margin trading operates almost exactly the same way as it does in the cryptocurrency market. The only difference lies in the assets being traded: on traditional exchanges, these assets may include currency pairs, securities, or derivative contracts, rather than digital assets.

In our 21st century, with the development of new technologies and online trading in particular, trading on margin has become accessible to absolutely everyone interested. It has also penetrated a new market – the cryptocurrency market. 

How margin trading works

Let's delve into more details and take a closer look at how all this actually works. We'll tell you about a few key concepts that are enough to understand the bigger picture.

Earlier, we discussed that the trader borrows funds from the crypto exchange. Thanks to this, they don't need to have a huge investment capital. They can easily multiply it by taking out a loan secured by the trading platform.

In other words, collateral is the trader's own funds locked in the broker's account. If the trader is unable to repay the borrowed funds, the broker confiscates the collateral. For the lender, collateral is a guarantee that they will not incur any losses. For the trader, the amount of collateral determines how much money they can borrow.

At the core of it all lies the margin itself. This term refers to the amount that a trader must provide in order for the broker to allow them to open a position. It is calculated as a percentage of the difference between the position's value and its collateral, and is recalculated each time the trader opens a position. Margin is essential because it is the only way a crypto exchange will provide leverage to the trader.

In turn, leverage is the ratio of borrowed funds to margin. It's the size of the leverage that determines how much the trader's purchasing power will increase. For example, a 1:10 leverage will allow trading with an amount ten times larger than the initial deposit. The size of leverage in leveraged trading can vary from 2x to as much as 100x.

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Now let's talk about the scary stuff. Every margin trader is most afraid of two things – margin call and liquidation.

A margin call is almost literally a "call" from the trader's lender. It's when the exchange notifies the trader that their collateral has fallen below the required level. In other words, the broker informs the user that they need to urgently deposit additional funds into their account to increase the collateral level.

If the trader doesn't respond to the margin call, then liquidation occurs. In this case, the crypto exchange forcibly sells the trader's assets to cover its losses.

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Long and short positions

Now let's see how you can trade on margin. In other words, what positions a trader can open and what the difference is.

A long position involves buying an asset with the expectation that its value will increase in the future. Traders often prefer to use leverage when taking a long position because it allows them to amplify potential profits when they sell the cryptocurrency. The logic here is as follows:

  • You open a position ➝ the cryptocurrency price rises ➝ you sell the asset ➝ profit.
  • You open a position ➝ the cryptocurrency price falls ➝ you incur losses ➝ no profit.

With a short position, it's exactly the opposite. Here, the trader sells the asset and hopes that it will decrease in value in the future. Then the trader can buy it back at a lower price.

  • You open a position ➝ the cryptocurrency price falls ➝ you buy back the asset ➝ profit.
  • You open a position ➝ the cryptocurrency price rises ➝ you incur losses ➝ no profit.

Interestingly, opening short positions is much riskier than going long. With short positions, a trader's potential losses are not limited. Theoretically, the price of the chosen digital asset could rise indefinitely. This means that losses could also be infinite. Therefore, trading in short positions is suitable only for very experienced participants in the crypto market.

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Types of margin trading

Let's turn to another classification. Both modes of margin trading we're about to discuss are equally popular among traders, but they have their own features and risks.

If a trader chooses an isolated margin, they will have to separately secure each of their trades. All of the trader's open positions seem to exist "separately from each other", and the profitability or loss of one will not affect the others.

Isolated margin has obvious advantages: potential losses will affect only one trade and will not impact all the others; the same applies to position liquidation. But there are downsides too – potential profit will also be limited to just one trade, making it less than it could have been.

In the case of cross margin, everything works the other way around. Here, all of the trader's funds are used as collateral for all of their open positions. This means that the margin ratio and potential losses will be calculated based on the total value of all open positions.

The advantage of this strategy is that profits from one trade can cover losses from all others. The downside is that all of the trader's open positions may be liquidated due to one losing trade.

It's important to note that cross margin is obviously a riskier trading mode, suitable only for very experienced traders. Yes, such a strategy significantly increases potential profit, but it also increases risks.

On the other hand, trading on isolated margin is suitable for newcomers to the market as it limits potential losses and minimises financial risks.

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Benefits and risks of margin trading crypto

Now you know how trading on margin works. Hooray! Let's summarise, starting with the benefits of margin trading:

  • Increased potential profit. By using borrowed funds, traders can open larger positions.
  • Portfolio diversification. Trader's capital is increased with borrowed funds, allowing them to invest in a greater number of assets.
  • Protection against market downturns. Traders can use margin trading to hedge their positions against unexpected cryptocurrency price crashes.

Nevertheless, trading on margin remains a highly risky process. Every trader who wants to try their hand at this type of trading must be absolutely sure that they understand all the risks of margin trading:

  • Increased losses. In unsuccessful trades, losses can be significantly greater than when trading with one's own funds. And when trading with a high leverage ratio, losses can amount to 100% or more of the deposit.
  • Margin call. If a trader's losses exceed a certain level, the broker may require additional funds to be deposited.
  • Liquidation. If a trader fails to meet a margin call, the broker may close their positions, leading to significant losses.
  • Elevated risks. Margin trading becomes particularly unpredictable during periods of volatility in the cryptocurrency market.

Choosing a crypto margin trading platform

If all these challenges haven't scared you off, your next step is to choose the right margin trading platform. Today, there are many of them in the market, and choosing one is no easy task. Here's a list of factors to consider when choosing a crypto margin trading platform.

1. Reputation and reliability. First and foremost, look for platforms that have been in the market for a long time and have gained popularity within the community. Study user reviews and get to know the platform better. Also, pay attention to whether the platform is licensed and compliant with regulatory requirements.

2. Security. Make sure if the platform you've chosen has experienced any hacking incidents or security issues. Find out what security measures it employs, such as encryption methods, registration procedures, and user account protection measures.

3. Trading conditions. Read the trading rules on the platform that catches your eye. It's a good idea to find out what trading fees exist on the platform, what deposit requirements there are, and what trading pairs are available in advance.

To narrow down your search, we've picked some popular margin trading platforms for you:

Binance. This cryptocurrency exchange offers leverage of up to 125x. It's also a leader in trading volume and liquidity. Registration on the platform requires verification.

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Binance website

Coinbase is another popular player in the market. The feature is available for Coinbase Pro customers. The platform offers leverage of up to 3x.

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Coinbase website

On Bitget you can also engage in margin trading. Registration requires verification. Additionally, the trading platform offers trading bots and copy trading functionality.

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Bitget website

Bybit offers similar functionality. The platform allows trading with many currency pairs. Keep in mind that margin trading on Bybit incurs spot trading fees, interest, and position closing fees, and registration also requires verification.

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Bybit website

Managing risk in margin trading

We've already discussed many risks associated with margin trading, regardless of the positions or strategies a trader may prefer. Particularly, risk management exists to minimise dangers and protect funds invested in trading. Here are a few key rules that can be useful:

Setting stop-loss orders. This order executes a sale when the price falls below the specified level, which is also called a stop-price. If a trader sets a stop-loss order, the exchange automatically sells their asset once the market price reaches a specified decline. Such orders are one of the main ways to prevent money losses.

Position sizing. The main essence of this strategy is to constantly compare the total size of all trading positions of the trader with the volume of their capital. The secret is to ensure that the money allocated for opening and maintaining positions constitutes a certain (and not too large!) percentage of the total amount of funds. This way, the trader controls how much potential losses can affect their budget.

Diversification. Here, a trader allocates their funds among different assets. For example, Bitcoin (BTC), Ethereum (ETH), Toncoin (TON), etc. In this case, if one digital asset begins to decline, the overall impact on the investment portfolio will be mitigated by the presence of other cryptocurrencies.

Monitoring margin levels. As previously discussed, the margin ratio is the ratio between the value of the collateral and the value of the trader's position. It is crucial to monitor this indicator to avoid undesirable consequences, such as margin calls or even the liquidation of a position.

Conclusion: navigating the world of crypto margin trading

Margin trading is a powerful tool in a crypto trader's arsenal, but it requires a responsible approach and deep market knowledge. Success in this area depends not just on strategy but also on the ability to manage emotions and risks effectively.

🤔 Do you want to try margin trading? Share your views in our socials! 

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Here are three other cool articles: 

What is a crypto faucet?

Understanding yield farming

How to add Polygon to MetaMask: a comprehensive guide

This article is not investment advice or a recommendation to purchase any specific product or service. The financial transactions mentioned in the article are not a guide to action. It’s not intended to constitute a comprehensive statement of all possible risks. You should independently conduct an analysis on the basis of which it will be possible to draw conclusions and make decisions about making any operations with cryptocurrency.

Maria Kachura
Maria Kachura

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