What is Margin Trading?
Margin trading is a form of trading where an outside person supplies funds. It is true that traders do not control the amount they’re trading. They have access to more capital than simple trading accounts. These accounts allow users to leverage trades, in simple words, amplify their capital at increased risk. Margin trading is very popular in International Forex (Foreign Exchange) market; however, it is also widely used in the commodity, stock, and cryptocurrency markets.
In the cryptocurrency market, funds are supplied by cryptocurrency traders, who make money from margin trading.
How does Margin Trading work?
In margin trading, the trader needs to secure a particular portion of the order, also known as a margin. The amount of margin required and the beginning amount of investment (Margin) are determined by the leverage employed. For example, if a trader places the order for $1,000 at 10:1 leverage, then the first investment (Margin) required is $100.
In simple words, it is possible to claim that the trader owns just $100, but due to the leverage of trading, they could trade with just $1,000 and make a profit with only a small investment.
What is Leverage in Margin Trading?
Different exchanges and markets offer different rules regarding leverage and margin trading. The leverage ratio of the market for stocks is 2:1, and future contracts are traded using a leverage ratio of 15:1. The range of leverage will be greater in the Forex market, which generally trades at 50:1 but can be increased to 500:1. The leverage offered by the cryptocurrency market can range from 2:1 to 100:1.
Crypto traders indicate the leverage ratio using “X,” such as 2x, 5x, 10x, and 100x.
The trader can make use of this type of trading for both short and long positions. A long-term position indicates it is likely that the price would rise (assumption), while an option for a short one means that the price will fall. It is important to remember that the funds they’re trading with aren’t theirs but borrowed as such, and traders may be required to end their trades at a loss (only in the event that the broker requires them to do so). Many cryptocurrency exchanges allow money for margin trading, and the users are in complete control over trades and which includes closing the trades and when to keep the trades.
Bitcoin Margin Trading
Margin trading is dangerous, and when it involves the cryptocurrency market, the risk is increased. The cryptocurrency and Bitcoin markets are extremely volatile, and this is what draws the attention of traders who trade on swings and scales. It takes lots of experience and effort to analyze the market and then open the long/short positions. The entries and exits should be determined prior to making any trade. Major cryptocurrency exchange offers lucrative leverages up to 50X in Bitcoin margin trading.
What is Liquidation?
Liquidation is a crucial concept when it comes down to Bitcoin margin trading. Suppose we assume that a trader has an open position. Liquidation occurs when the price falls to a certain level at which all margins will be utilized.
The liquidation cost by depositing funds into their accounts and adding more contracts in the position. Should the user be unable to decrease the liquidation, and the price is at the liquidation rate, the position will be closed automatically with the help of the exchange.
The trader is liable to lose all margin (Initial investment with no leverage) of the trade. The liquidation price varies for different leverage levels for 2x leverage, with a liquidation price around 50 percent lower than the purchasing price, and for 10x, the liquidation cost is about 10 percent lower than the buying price. For example, a user owns $100 and opens a long position in a margin trade for $1,000, at a leverage of 10x. The position would face liquidation when the price of the cryptocurrency falls by 10% from the price it was purchased.
Benefits to Bitcoin Margin trading
The primary benefit of Bitcoin Margin trading is that the gains are huge and swift due to the large stakes and leverage. An investor can make an impressive amount of money even with a tiny change in the price. Bitcoin margin trading provides users with an opportunity to test their skills and perseverance.
Moreover, a skilled trader can exploit the significant movement of cryptocurrency prices and make a huge profit from a meager sum of investment. The risk of losing capital is also the same.
The Disadvantages to Bitcoin Margin Trading
The business of trading on margins is extremely risky, and the cryptocurrency market is taking the risk to a whole new level. A slight change in price could result in a huge loss. The risk is increased with the amount of leverage; high leverage means higher risk.
The trader must make use of stop-loss on every trade to minimize the possibility of losing all money (Liquidation). Stop-loss offers traders the chance to recover from losses.
Margin Funding Customers who aren’t keen on taking a high risk in leverage trading could profit from a different approach called margin funding. Certain trading platforms and cryptocurrency exchanges provide the option of margin funding which allows users to secure their funds with other traders who are making use of leverage trading.
Margin trading can be a way to generate quick profit in a short time with considerably low investment (making a profit at $1,000 with an investment of $100). When leverage is done in a way that is risk-controlled, the portfolio can be boosted by a lofty ROI (Return on investment). However, margin trading can be exceptionally risky as there is the possibility of losing everything in one trade, even if there is a slight drop or increase in price. The trader must have a high level of expertise and strategies for managing risk. The fluctuation in the market for cryptocurrency elevates the risk exposure.
Disclaimer: Information provided in this article should not be taken as financial advise under any circumstances. Do conduct your own due diligence and consult your financial advisor before making any investment decisions.
Camila is working as a Senior Writer with Coinfea. She has completed her bachelor’s from a reputed college. She loves to write about trading technologies like crypto and blockchain.