Margin Trading in Cryptocurrency – How Does It Work and Should You Be Doing It?
Margin trading in cryptocurrency also gets referred to as several other terms. Some people call it shorting bitcoin, while others may refer to it as trading in cryptocurrency with leverage. Even though all of these refer to the practice of margin trading in cryptocurrency, it is easy to get confused when people use the terms interchangeably.
Margin trading in cryptocurrency is not a very complicated process, but it is a volatile one. Traders can use the price fluctuations of cryptocurrency markets to earn a profit, whether it is bears or bulls. But what exactly is crypto margin trading, and how does it work? And more importantly, should you be doing it?
What Is Margin Trading in Cryptocurrency?
New traders often feel overwhelmed trying to decipher the complications of margin trading in cryptocurrency. If you have tried to Google how it works, you may have come across a glossary of terms like leverage, shorting, HODL, FOMO, forking, margin calls, and several more, which you have no idea about.
However, the basics of margin trading in cryptocurrency are not that complicated. Cryptocurrencies are quite expensive, so most people cannot buy them. Therefore, as a margin trader, you borrow capital to increase your buying power so that you can open positions of far greater value than your account balance.
Margin trading in cryptocurrency is similar to margin trading in traditional finance. It allows you to earn huge profits, but there are additional risks as well. When you are margin trading in crypto, you borrow the funds from a third party like a broker or margin lenders. To do that, you will have to invest an initial deposit and open a position in crypto.
You also have to hold a certain amount in your account to maintain your position. When you are trading on a lending platform, your initial margin deposit will be held by the platform as collateral. Your leverage amount for margin trading will also depend on the rules of the platform you are trading with and your initial deposit.
What Is ‘Going Short’ and ‘Going Long’?
When you open a position in crypto margin trading, you can either go short or long. When you choose to go short, you bet against the price of the cryptocurrency. That means you anticipate that the Crypto value is going to fall. The long position is the opposite of it, which means you are betting that the cryptocurrency price will increase.
Margin trading in cryptocurrency is not a very complicated process, but it is a volatile one.
Your profits will depend on your initial deposit and your leverage. The initial deposit and leverage will vary between different crypto exchange platforms. Some platforms offer a 10 X leverage while others can offer up to 200 X.
What Are Margin Calls and Liquidation?
When you open a position and borrow money from a platform to trade in cryptocurrency, the platform will take measures to reduce their risk of losses. So when the market moves against your bet, the platform might ask you to increase your collateral so that your position is secure.
It is called a margin call, and it happens when the value of the cryptocurrency falls below a certain amount. Most platforms will notify you, but it is also essential that you monitor the margin levels.
But if the margin levels fall below a certain amount, the platform might close the position and forfeit your initial deposit, also known as liquidation of the trade. A platform will liquidate a trade to ensure that it does not lose any money beyond your initial margin.
Should You Margin Trade With Cryptocurrency?
Margin trading in cryptocurrency allows you to reap enormous profits. When done intelligently, you can earn 100 times more profit than traditional financial trade. You can make a profit even when the price of the cryptocurrency falls by going short on it. However, there are some things that you should bear in mind when margin trading in crypto.
- If you have just begun margin trading in cryptocurrency, begin with small leverages. A 2X or 3X leverage is good enough to start with, as it reduces the risk of liquidation. Always ensure that your initial deposit is what you can afford to lose.
- Always set a stop-loss to prevent liquidation. That way, you will only lose a part of your initial deposit if the trade does not go the way you had planned.
- Do not treat margin trading in cryptocurrency as a passive investment. You always have to monitor your positions because an unexpected turn can cause you significant losses. Therefore, you must be prepared to react if the trade does not go according to your plan.
- Do not rush to buy any assets that are growing rapidly. It can be a pump-and-dump scheme where the market participant is manipulating the rate as they have limited assets to liquidate. The value will fall as quickly as it has risen, and you will suffer significant losses.
Margin trading in cryptocurrency allows you to earn substantial profits, diversify your position, and learn trading strategies. The profits are better because of the high relative value of trading positions, and you can open multiple positions with little investment.
However, crypto margin trading can also result in significant losses because of its extremely volatile nature and greater risks. Therefore, if you are new to margin trading in cryptocurrency, you have to be more cautious.
It is advisable to acquire knowledge about hedging and risk management. Even with adequate knowledge to identify market trends, entry and exit points, it is always best to remain cautious with crypto margin trading.