Cryptocurrency Margin Trading - Explanation for Beginners

The article runs about all the peculiarities of margin trading which may be useful for inexperienced traders
Cryptocurrency Margin Trading - Explanation for Beginners

What is Margin Trading? 


Margin trading, to put it simply, is the practice of taking loans from a broker in order to buy more than you can afford. Before looking into the peculiarities of cryptocurrency margin trading, let us consider one simple example. A person, who wants to buy a $200,000 apartment with only $20,000 on hands, will have to go to a bank and apply for a loan (a leverage). After performing the customer due diligence, the bank may approve his mortgage and give money for investment. If the price of apartment goes up, this individual will significantly profit off his small initial investment. 
 

Bitcoin Margin Trading 


Bitcoin margin trading is, in fact, very similar to getting a mortgage, but here you deal with crypto instead of real estate. You open a position with leverage and pump up your buying power by taking loan from a broker on one of the cryptocurrency exchanges that allows margin trading.
 

NB! The money lent to a trader come from an operating account, so customer funds are not used by a broker. However, some exchanges allow borrowing directly from other users. 

Then you can invest your leveraged funds in any available cryptocurrency that, as you believe, has the potential to significantly increase its value. For example, you can buy 100$ worth of Bitcoin Cash (BCH) with only 20$ of your own money (if the leverage ratio is 1:5). If the price of BTC remains the same, you break even, but any BCH price spike will result in profit (that would be significantly lower if you weren’t trading with leverage).       
 

Leverage Ratio 


The sum of money that an investor is able to borrow from the exchange is determined by the leverage. Leverage amount is presented as ratio (1:2, 1:3 and son on). Traditional traders are conducted with 1:1 leverage.    

Compared to Forex trading, cryptocurrency exchanges have a rather low amount of leverage due to the fact that this market is still highly volatile. Cryptocurrency traders will not find any brokers that are willing to lend out funds on a mammoth scale with 1:500 leverage or higher.    
 

Margin Trading Risks 


Before engaging in margin trading with cryptocurrencies, you have to remember that it comes with significant interest rates and fees. Inexperienced investors may be tempered to take advantage of market volatility and gain huge profits, but there is always a huge risk if you choose to trade with leverage.

  1. Equity threshold. In order to engage in margin trading with Bitcoin, your equity level has to be above a specific threshold (for the majority of exchanges it is about 30 percent). If your account’s equity falls below this threshold, you won’t be allow to open a position unless you make an additional deposit.
  2. High interest rates. Crypto exchanges profit from Bitcoin margin trading (US) by setting interest rates which are quite high (especially, for long-term investments). Consequently, if the predicted price jump doesn’t happen anytime soon, it is better to close a position, since the constantly increasing interest rate may soon diminish your profit. Therefore, trading with leverage is a good option if you want to take advantage of an ongoing bullish trends, but it is a no-go zone for beginners who want to capitalize on long-term investments.  
  3. Huge losses. As mentioned above, the instability and sensitivity of crypto market won’t let broker implement a higher amount of leverage. Even opening a position with, say, 1:5 leverage may lead to huge profits if stars align. However, you may lose everything as well. Apart of sending a  'goodbye kiss' to your initial investments, an investor may find himself in a situation when he will have to give back the borrowed money and pay back the interest rate.


As you can see, before diving into the wilds of Bitcoin margin trading (USA), you have to minimize your risks to almost non-existent. It can be a powerful tool for cryptocurrency investors, but make sure that you won’t sink below a break-even point, and you initial investment will cover trading fees and the interest rate.
 

Forced Liquidation 

  
Once we’ve covered the risks, it is also to introduce the notion of forced liquidation. Forced liquidation presupposed that all you margin positions get closed to make sure that you won’t default on your borrowed funds. It is vital to regularly check your positions and reduce their size to prevent substantial losses and consequent forced liquidation.       
 

Best Margin Trading Exchange  


A large number of cryptocurrency exchanges (Bitfinex, Kraken and so on) offer their users a possibility of trading with leverage. No matter what exchange you choose, the process of opening a margin position generally remains the same. However, there may be significant differences when it comes to fees, the initial equity and the amount of leverage and available assets, so it’s completely up to you to choose the best margin trading cryptocurrency exchange. 

To show you how margin trading works, let’s have a look at a Hong Kong-based exchange Bitfinex that allows opening positions with up to 1:3.33 leverage. The short guide, which presented below, will show you how to use this Bitcoin exchange for margin trading with both long and short positions.     

  1. After creating an account and depositing funds, you have to choose the ‘Trading’ section and select a desired trading pair. 

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  2. Then go to the ‘Margin’ section and place an order specifying the amount of your investment, leverage ratio and order type. 

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  3. Click the ‘Margin Sell’ button in order to finish your order and open a position. 

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  4. Your position can be closed at any time by using the corresponding button. Borrowed money will be automatically repaid to your broker while gains/losses will be credited to your margin wallet.  

Here’s a table which lists popular exchanges with margin trading along with the maximum amount of leverage that they can offer. 
 

Crypto Exchange 

Maximum Leverage  

BitMEX

1:100 (BTC)  

1:50 (ETH)

1:20 (XRP)   

Bitfinex

1:3,33

Huobi

1:5

Poloniex

1:2,5

 

1:5 (BTC and ETH)


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