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A Beginner’s Guide to Margin Trading

When it comes to trading crypto, one tool that can amplify your investment potential is margin trading. Imagine you’re navigating the world of online crypto trading, and you’ve got a strong hunch that one of your assets is ready to soar. You’d love to increase your holdings, but you’re not keen on shuffling around your investments or pouring in fresh capital. That’s where margin trading steps in.

In simple terms, margin trading involves borrowing funds from a third party, like a brokerage or exchange, to increase your investment without the need to pump in more money. In this article, we’ll dive into details of what Margin Trading is, how it operates, and who it is suitable for. Let’s take a look:

What is Margin Trading?

Margin trading is an advanced strategy that allows you to trade with more funds than you actually own. How does it work? Traders can borrow money directly from a crypto exchange and begin trading with more funds than reside in their exchange wallets.

Typically, you can borrow funds ranging from 2x to 100x of your investment, depending on the exchange. Some exchanges even allow amounts exceeding 100x. This borrowed amount is known as leverage, and here’s the catch: the higher the leverage, the riskier the trade.

To dive into a trade, you first deposit funds into your margin account, serving as both your borrowing base and collateral. Yes! Your investment will also act as collateral. This means that if the asset’s price drops below a certain point, you risk losing your entire investment.

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Margin Trading Example

Let’s break it down with an example. Borrowing 5x leverage for Bitcoin means you could gain a 25% profit with a 5% increase in BTC price. A 20% surge? You double your initial investment. But, and it’s a big but, higher rewards mean higher risks.

On the other hand, should Bitcoin’s price fall by 5%, you lose 25% of your original investment. A 20% dip? You can tell your funds goodbye. That’s why margin trading is a form of trading best suited for experienced traders.

Margin Trading Terms Explained for Beginners

Understanding margin trading as a beginner can be tricky due to all the terms and jargon involved. To make things easier, here are some commonly used words in margin trading that you should get to know. Understanding these terms will significantly improve your grasp of margin trading.

Long Position

Long Position Margin Trading

In crypto trading, opening a “Long position” is like placing a bet that the price of that specific cryptocurrency will rise in the future. It’s essentially a vote of confidence in the currency’s potential upward movement.

Here’s a quick scenario: Imagine you decide to go long on Bitcoin with a 10x leverage. If Bitcoin’s price increases by 5%, your profit shoots up by 50% on the initial investment. When you hit your profit target, you can opt to close your position and secure your gains. Going long is all about anticipating gains and strategically closing the position when your targets are met.

Short Position

Short Position Margin Trading

A “Short position” is the mirror opposite of going long. Here, you’re anticipating a drop in the price of a cryptocurrency in the near future. It’s like placing a bet against the currency’s value. Basically, you sell a cryptocurrency you don’t own at a high price with the intention of buying it back when the price takes a dip.

Here is another scenario: If you decide to short-sell Bitcoin with a 10x leverage and the price of Ethereum falls by 5%, you make a tidy 50% profit on your investment. However, If the asset’s price goes up by 5%, you’re looking at a 50% loss on your total investment. And if the price makes a 10% jump, you could end up losing your entire investment. Short positions require careful consideration, as losses can escalate swiftly if the market doesn’t move in your favor.

Margin

Margin is the total amount required for a trade. It’s the sum a trader must commit to open a long or short position. The borrowing capacity depends entirely on the margin you decide to contribute. The margin you dedicate is the key factor in determining how much funding you can borrow.

Leverage

Leverage is the amount of assets you borrow from the exchange to increase your trading power. It’s a tool that lets you control a more substantial position than your actual investment. You have the flexibility to opt for low leverage, like 2x, or go daringly higher, up to 100x, if you’re feeling adventurous. The amount of max leverage you can choose is influenced by factors such as your margin amount, the chosen exchange, and the specific cryptocurrency you’re trading.

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Collateral

Collateral

Collateral is the complete margin amount you’ve allocated to one or more positions. It serves as a reassurance to the exchange that you have the means to settle your debt if the trade takes an unfavorable turn. For instance, if you commit $500 as a margin for a long or short position, that $500 is also your collateral. Regardless of the chosen leverage, reaching the liquidation price means risking the entire collateral, which in this case is the full $500.

Liquidation

When you kick off a trade, your broker calculates a liquidation price based on your margin and chosen leverage. If that liquidation price is hit, you will end up losing your entire margin. In long positions, the liquidation price is below your entry price. If the price drops to that calculated number, you will be liquidated.

On the other hand, if you are shorting an asset, the liquidation price will be above your entry price. That means if the price of the asset starts to rise and goes above a certain number, you will be liquidated. Once you open the trade, the exchange gives you the calculated liquidation number so that you can manage your risk accordingly.

Margin Call

A margin call is a signal from the exchange that you need to inject more margin into your position to keep it active. In simple words, it’s a request for additional funds. If you don’t meet this requirement, the exchange has the authority to close your position abruptly to offset the deficit at any given moment. A lot of beginners end up ignoring it and end up facing the automatic closure of their positions.

Margin Trading Order Types for Beginners

Various exchanges provide a range of order types for margin trading. However, as a beginner, it’s important to get familiar with the main order types that will help you open, manage and close your position. Let’s take a look:

Stop-limit Order

Stop-limit enables you to open a new position when the asset’s price either surpasses or dips below a specified value. It lets you decide the price at which you want to enter the trade. Most experts like using stop-limit orders as it removes room for error and helps them stick to their devised strategy.

Market Order

A market order is completely different from a stop-limit order. With a market order, you are opening your trade at the real-time price of that asset. Unlike stop-limit orders, market orders are not precise at all. The crypto market is highly volatile, and this type of order can be risky. It’s only used by experienced traders when they are scalping and need to enter a trade quickly.

Stop-loss Order (SL)

Think of a stop-loss order (SL)as your safety net in trading. With a stop-loss order, you gain the ability to shut down your position once the asset’s price hits a specific value. Why use it? Because it’s a risk management strategy. By setting a predetermined value in your stop-loss order, if the asset’s price drops below that threshold, your trade automatically closes. It’s a protective measure to ensure you don’t incur more losses than you’re comfortable with.

Take-Profit (TP)

Take-profit (TP) is an order type that kicks in when you’re making a profit and the asset’s price hits your predetermined target. It’s a proactive move, allowing you to secure your gains when the market swings in your favor. Knowing when to take profits is important if you want to succeed in margin trading, and TP helps you make sure that you don’t miss out on your targets.

Margin Types: Isolated vs Cross

Once you deposit funds into your margin account, you can use them in two different ways:

  • Isolated Margin
  • Cross Margin

Isolated Margin

Isolated margin refers to allocating a specific margin to an individual position, preventing it from being shared across various positions. The key advantage lies in its isolation; any margin deficit or liquidation in one position does not impact other positions in the portfolio. Isolated margin is particularly useful for closely monitoring speculative and highly leveraged positions.

Cross Margin

Cross margin is a smart strategy where you can use your margin balance across various positions. This means if you make a profit in one position, the extra margin can cover any losses in another. The main benefit of cross-margin is that it can potentially save you from margin calls and the unwanted forced selling of a losing position. It’s a risk management move that helps you improve your overall portfolio performance.

Important Tips for Margin Trading

For successful margin trading for beginners, here are some key tips:

  • Begin Small: Start with minimal leverage to ease into the process.

  • Employ Stop Losses: Use stop losses to prevent potential losses and protect your investments.

  • Choose Liquid Assets: Focus on highly liquid cryptos for smoother trading.

  • Regular Monitoring: Keep a close eye on your margin levels and account equity daily.

  • Maintain Reserves: Have reserves ready to meet any unexpected margin requirements.

Remember, moderation is the key. Start with caution and gradually increase your involvement as you gain experience in risk management.

Where to Begin Margin Trading?

You can start your margin trading journey by signing up and depositing funds on any of the reputable cryptocurrency exchanges. Some of the best exchanges include:

Conclusion:

In summary, while margin trading does open doors for better profits, it equally heightens risks. Begin cautiously, implement stop losses religiously, and steer clear of excessive margin exposure. Make sure to keep learning about the market and strategies and improve your understanding of risks. To improve your skills, consider signing up on a demo trading platform to refine your strategy in a risk-free environment. Also, if you are fairly new to crypto, it is better to trade on the spot market first and get some experience.

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