A recent study revealed that more than 40% of retail investors are into margin trading. The biggest advantage of margin trading is that the trading strategy allows even cash-strained traders to aim for bigger trading positions and higher profits.
It’s self-explanatory why this particular trading method has always attracted investors and traders in large numbers. The crypto trading market is largely inspired by the traditional trading market and margin trading is equally popular among crypto traders and investors as it is with traders in the traditional trading scene.
Cryptocurrency margin trade
What is meant by margin? And, why is it being used interchangeably with the word leverage? Why do a large number of traders and investors prefer margin trading? Well, all the questions will be answered in this post.
Leverage and margin
First, to understand the meaning or implication of “margin” in crypto margin trading, you have to understand the complete concept of the trade. Margin trading is a form of trading where you are allowed to trade with borrowed funds. If you are in a cash crunch but still want to open a large trading position, margin trading will allow you to aim for your ambitious trading goals with the privilege of borrowed funds.
Leverage- In margin trading, “leverage” refers to the extra boost you add to your trading capital in the form of borrowed funds. You will be able to borrow the funds from the trading platform where you will sign up for the trade. You will be able to choose from a wide range of leverage, such as 1x to 2x to 10x, and so on. Highly ambitious traders can opt for even higher leverage, such as 50x or even 100x.
Margin- Crypto trading platforms need collateral from the trader’s side for lending the funds. There are two kinds of margins when it comes to margin trading. One is the initial margin i.e. the margin amount you would need to provide to register for your margin trading account. The other is the maintenance margin. You will need to have this margin constantly present in your leverage trading account to ensure your trading position is active.
The leverage provided by the crypto trading platform will be calculated on the basis of the margin you would be able or wish to provide to the trading platform. So, for example, you will be able to deposit $1,000 as the “margin” for your margin trading position. Now, if you take 10x leverage, the total trading capital that you would have for trading would be $10,000.
All the profit or loss that you will attain or suffer with the margin trading will be calculated on that leveraged amount, say $10,000 (in this case).
Margin call- This is a warning call from your trading platform, says, a crypto exchange. If your trading position meets with a loss, your maintenance margin will get liquidated. In that case, you will again have to refill the margin to keep the trading position intact.
In that light, the trading platform will send you margin or reminder calls to remind you to refill the maintenance margin immediately. If you fail to answer the margin call, the trading platform will close down your trading position.
Why do traders prefer margin trading?
Margin trading enables traders to trade with amplified funds. When it comes to trading, the more capital you are able to put in, the higher the overall profit amount would be provided the market swings in your favor. But the best part is, in this case, you won’t need to provide much capital from your own drawer to aim for a bigger trading position.
So, if we take the example placed above, the trader is able to open a considerably bigger trading position worth a whopping $10,000 with just $1,000 from his/her own share. This means, if the market rises and he/she makes a profit, the profit will be earned on $10,000 and not on $1,000 (his/her own share). In other words, in this margin trade, the trader makes a huge profit of a $10,000-worth position yet with just depositing $1,000.
You don’t have the same facility in other trading methods. In other trading methods, the profit incurred will be calculated based on the exact amount that you have been able to provide for the trade. So, in other trading methods, if you are able to provide no more than $1,000, the trading position and profit incurred (if any), will be calculated based on that particular amount, i.e., “$1,000” in this case.
Profit in both bull and bear markets.
You will prefer any form of crypto trading if the market is passing through a bullish phase. But you might encounter losses if the market suddenly gets into a bearish phase. However, crypto margin trading offers protection for traders here.
The trading method allows traders to enjoy profit when the market passes from “buy in the dip” and “sell in high” situations. This is called trading with a long position.
However, unlike regular forms of crypto trading methods, margin trading methods offer protection to your trading portfolio in a bearish market through a short trading position.
Margin trading advantages and disadvantages
Advantages of Margin trading
The fundamental motivation for investors to engage in margin trading is the opportunity to gain a competitive advantage via the prudent use of leverage. Margin trading is based on the principle that more money may be used to buy assets, therefore boosting overall buying power. Investors may leverage their capital by using it as collateral for loans higher than their capital on hand, allowing them to purchase additional securities.
This is why trading on margin may significantly increase earnings. Again, since you have used loans to invest more heavily, the effects of price rises on your portfolio will be magnified the more securities you have. If the securities you’ve pledged as a collateral rise in value, too, you may be able to raise your leverage ratio since your collateral basis has grown.
In addition, margin trading offers greater leeway than traditional loans do. Your broker’s criteria for maintaining a margin account may be unstructured or automated, and you may not have to make regular repayments. If you have a margin account, your loan will likely remain active until you sell your assets, at which point you will be expected to make a final payment.
Disadvantages of Margin trading
Investors who engage in margin trading because they believe it will increase their potential profits should also be mindful that it will also increase the size of any losses they incur. It is possible for an investor to lose more than their original equity investment and then some should the value of assets acquired on margin suddenly decrease in value. There is an additional cost associated with trading on margin, in the form of interest costs charged by your broker. This cost is incurred whether or not your margin account is profitable.
Because of the need for investors to maintain a certain level of equity, they may get a margin call. The equity value of the shares owned by the client has decreased, prompting the broker to demand that more cash be deposited into the margin account. Investors should plan ahead to ensure they have enough money to cover the margin call.
If an account’s value declines so quickly that it falls below a specific margin requirement, or if an investor is unable to provide further equity, the account may be liquidated by the broker. In order to fulfill the broker’s demand, the client will be obliged to liquidate the margin account holdings, which might result in a loss.
Final words for margin trading
The post above has all the great things to say about margin trading in the crypto scene, and for all the right reasons. But you should also keep in mind the fact that crypto margin trading could be risky as well. If you face losses, the losses won’t be calculated on your margin amount, say, $1,000 (based on the example above), but on $10,000 since you are trading with leverage. So, naturally, the scale of loss would be way higher than what you could have faced with just $1,000 in trading capital.
Thus, be careful of the amount of leverage you take and the margin you deposit. Make sure the margin you are depositing can be refillable if needed without putting much pressure on your regular finances. You must also keep the leverage level low.