A Simple Guide To Cryptocurrency Margin Trading
April 30, 2020 - 3 min read
Cryptocurrencies are all the hype in the trading market. Traders invest in the crypto sphere to gain leverage and higher returns. But what if you have a limited amount of capital to invest? This is where Margin Trading comes to your aid.
What is Margin Trading?
In simple words, Margin Trading is trading using borrowed money to increase the investment position and gain higher profits. The money is borrowed from the exchange or broker for trading against the funds already in your trading account. The leverage ratio varies from exchange to exchange and the money is lent accordingly. A leverage ratio is the ratio of the amount that a person is investing as compared to the amount he has in his trading account. That is if the ratio is 4:1 then, you need to have at least 1/4th (of the total value you want to invest) as cash in your trading account.
For example, you have $100 in your account; depending on the ratio of leverage say 2:1, you can borrow $100 more from the exchange and invest the total amount of $200. Remember, the money is lent on a higher rate of interest and a fee is charged for opening the position or investment with the exchange.
With greater return comes a greater risk of loss. The cryptocurrency market is a volatile market; here the returns are high but so is the risk of loss. If the market moves in your favor, the profits will be much higher than if you had invested your own funds only. But in case the market goes negative or not in your favor, it could lead to a high amount of loss as well.
What are the costs and risks involved in Margin Trading?
The major risk in Cryptocurrency Margin Trading is losing the invested amount and paying interest and fees. A fee is charged by an exchange offering you a platform for margin trading. This is an on-boarding fee to open your position for margin trading. Other than this, when you borrow money from an exchange or broker, a high rate of interest is charged. This interest is to be paid with the money borrowed back to the exchange after completion of your trading. When the market works in your favor, it is easier to return the money and interest from the profits gained.**
**However, the major risk is if the market goes south. In this case, most exchanges close your trading as soon as you lose the number of your own funds. When this happens, the exchange will stop the transactions and take the money that was lent back. This is called a “Call-In”. As soon as you start to lose the borrowed money, the related exchange will generally call-in your margin trade. A call-in can be avoided if the trader invests more amounts into the margin trading.
Types of Margin Trading
Margin Trading is generally of Two Types:-
In long margin trading, the trader generally bets on the price to go up. This means the trader expects the price of a certain currency going upwards in order to gain profits.
In short margin trading, a trader generally believes that there will be a drop in the price and invests his money against that cryptocurrency. Here, the profit is gained on estimating a drop in the prices.
**It is, however, important to understand that there are risks involved in both long and short margin trading.
Tips to consider before Margin Trading
Manage Risk- There is a possibility of gaining higher profit and the risk of losing everything. So, Risk management should be done in order to identify the amount of loss you can bear. A stop-loss point should be analyzed and you should stick to it.
Keep Track of Market- Cryptocurrency market is considered highly volatile. Margin Trading of cryptocurrency increases the risk factor. It is important to watch the market trend closely before investing in margin trading. It is advised to go for short term in margin trading and the fees and interest are bearable. In the long run, this fee and interest could be significantly larger to bear.
Start Small- If you are new to cryptocurrency margin trading, it is advised that you start with a low leverage level. This will help keep the risk and loss at a minimum and give you an understanding of the margin trading of cryptocurrencies.
In short, Margin Trading is a means to increase your buying power for a period of time in order to gain favorable returns. However, there are risks involved in Margin Trading and one should fully comprehend the know-how before going for Cryptocurrency Margin Trading.