Cryptocurrency margin trading for beginners - meaning and examples
So, maybe you’ve learned the basics of crypto trading, and you’ve even gotten pretty good at it! If you don’t have an enormous bankroll at your disposal, then you may be wondering where to get capital for trading.
There’s actually a process in place for that, and it’s called cryptocurrency margin trading. In this article, we’ll go over everything you need to know to begin trading on margin. We’ll also go over the dangers of it and what you need to know to protect yourself.
What is cryptocurrency margin trading?
Ever spot a really good trading opportunity that you wish you could jump but you just don’t have the capital to do it? Fortunately, margin trading can fill this need for you. When you buy cryptocurrencies on margin you are borrowing that money from the exchange in order to do so.
This allows investors to have a lot more options and a lot more opportunities to make profits, but it also comes with a substantial amount of risk that you should not take lightly.
How does crypto margin trading work?
When you trade on margin with an exchange you are taking out a loan. Sometimes this is from the exchange itself, but in some cases, you could also be borrowing your capital from other investors.
In either case, you’ll be expected to pay back this loan with interest. That means that you need to calculate your trades carefully to make sure your profits will cover everything and still leave you with something for yourself.
Investors should keep in mind that they likely won’t be able to walk into a margin trade with nothing to offer. Most exchanges will require a minimum deposit to participate, and they will have different leveraging options which you can use to take advantage of this deposit and increase the dollar value of your trades.
Leverage refers to the buying power you are granted by the exchange or broker. For example, you could put down $25 with a 4:1 leverage. You can then borrow $75 from the exchange, and then you’d be allowed to purchase $100 in cryptocurrency coins or tokens using that money. The exchange doesn’t really care what you do with the loan, but they will expect you to pay it all back to them, with interest.
Liquidation price explained
When you are trading on margin, the crypto exchange will be watching your account. They have an interest in your money, and they can’t allow you to lose everything. So, if your investment falls below a specified amount you will receive a margin call.
In some cases, this will be set as a percentage of your total investment, but in others, a ‘liquidation price’ will be set, and if the asset you’re trading falls below this price your assets will be liquidated. This could leave you either at a loss or scrambling to put in additional collateral to avoid the liquidation.
Example of cryptocurrency margin trading
Jimmy believes that Ethereum will be going up in value soon. Unfortunately, he doesn’t have enough free cash to make the kind of investment that he really wants. Instead, he goes to a cryptocurrency exchange that allows margin trading. He puts down $25 at 4:1 leverage. The exchange allows him to borrow an additional $75, and he invests $100 in Ethereum.
It seems that he was right about his play, and the price of Ethereum goes up. Jimmy makes a big enough profit to pay back his loan and the interest, and he still has some profit leftover to make more trades or build up his capital.
Of course, these trades can go wrong too, so always be prepared for that potential scenario as well. If the price of Ethereum was to go down significantly, then Jimmy’s story would’ve played out differently. His position would have been liquidated, and he would be forced to sell at a loss. He would make no profit, and he’d owe back his losses plus interest to the lender.
Is margin trading a good idea?
If you are experienced enough, then trading cryptocurrency on margin can be a valuable tool to increase your positions. If you don’t know what you’re doing though, then watch out. Trading on margin is an easy way to get yourself into debt. Make sure you’ve got a good deal of experience under your belt performing cash trades before you try to trade on margin.
Why margin trading crypto is dangerous?
Margin trading in traditional finance markets is already dangerous, but with cryptocurrency, it can be even worse. Cryptocurrencies are extremely volatile, and it’s easy to lose a lot of money very quickly. When trading on margin it’s important to never bet too much money on one trade as that could have disastrous consequences.
Margin vs short trading
Margin traders are looking to purchase assets which they think will go up in value. With short trading investors are looking to bet against assets that they think will go down in value. Both are done on credit from the exchange but with different goals in mind.
Margin vs cash trading
Dealing with cash is much safer than trading on margin. When trading with your own cash balance you won’t be accruing interest, and there’s no risk of a margin call that could ruin your day. However, with margin you have access to more capital, and if you’re pretty sure of your investments, then taking a loan from the exchange to further capitalize on it could be a good play.
Is there a working margin trading bot for cryptocurrency?
Due to the way that margin trading works, there does not seem to be a bot which will allow you to trade using margin yet. This has to do with the way that you close positions that makes it more difficult to automate.