Margin Trading Meaning
What is Margin Trading in Crypto?
Also called leverage trading, margin trading is a risky crypto trading strategy where a trader uses borrowed money, or leverage, from a crypto exchange or broker to increase their purchasing power. It gives the trader control over a larger position than their trading account balance can allow.
To utilize margin trading, traders need to establish a margin account that allows them to borrow funds from a third party. In return, traders provide collateral for the loan, which is typically a percentage of the loan amount. The amount of crypto you need to enter a leveraged position is called a margin (initial margin).
The position size a trader can open is determined by the loan amount and the leverage ratio, which is a multiplier representing the amount they can borrow compared to their capital. It ranges between 1x and 100x.
The trader can borrow a crypto asset at the current market price, sell it immediately, and then repurchase it when the price drops to repay the loan (short it). The trader then pockets the profit from the difference. Alternatively, they can borrow the asset at the current market price and anticipate selling it when its value goes up (open a long position).
Here’s an example:
Suppose you have an account balance of $200. Assuming you have 10x leverage, you can borrow crypto assets worth 10 times your account balance to open a position size worth $2000. The loan amount would be $2000 (position size) – $200 (initial investment) = $1800.
Scenario 1, the price goes up by 10%. Your initial investment of $200 (your capital) would result in a profit of $200. In scenario 2, the value drops by 10%. In this case, you lose your initial investment of $200, leading to liquidation, where the exchange automatically closes your trade to recover the borrowed fund.
Risks of Margin Trading
- Volatility Risk: The crypto market is unpredictable and prices can move in either direction without warning. Hence, margin traders are more exposed to losses than in traditional markets. Leverage amplifies a trader’s profits in case the crypto value rises, but also magnifies the losses if the price dips.
- Liquidation Risk:Liquidation occurs when the trader fails to meet the minimum margin requirements. Margin trading increases the potential for forced liquidation if a trader’s position moves against them.