The concept of margin trading is simple. Say you have a trading capital of $1,000. With margin trading, you can borrow additional funds to purchase an asset, for a total value that is more than your capital. That means you could trade $5,000, $15,000 or even $50,000 worth of assets while only having an actual sum of $1,000, depending on how much leverage your broker allows. Margin trading can be done with various instruments, including crypto currencies. While equity brokers usually allow leverage only up to 2:1, meaning you can buy up $2 of stock for every $1 in your account, the leverage offered by crypto brokers is far higher, in some cases reaching 100:1.
The power of margin trading is immediately clear. With a leverage of 50:1, a 2% move in your favour would give you a 100% profit on your investment. With 200:1 leverage, you could control $200,000 in crypto, although you only have $1,000 in your crypto wallet. Again, just as the opportunity is larger, so is the risk – a 0.5% move could either wipe out your account or double its value.
How It Works
Margin trading, when done correctly, magnifies the potential profitability of any given trading strategy. When applied to crypto currencies, which are known for their extreme volatility, the potential is even more clear. Most crypto exchanges only allow you to buy crypto currency directly in cash, meaning without any leverage. Other exchanges like Poloniex and Bitmex allow you to trade on margin by borrowing and paying interest on the borrowed amount. The loans are provided by other exchange users and crypto holders. Leverage for some of these exchanges can reach 200:1, however, it is usually best to use leverage of 10:1 or lower for sustainable long term profitability.
When you open a crypto margin trading account, you can see immediately on your screen your unrealized profits (or losses), margin value (your account value), net value (your account value minus fees) and the amount you are currently borrowing:
You will also see how much leverage you are employing (in the sample above it’s 2.5x) and your maintenance margin level (20%). The maintenance margin shows you the minimum balance you need to have to maintain your trading positions. If your positions move against you, the current margin, meaning your account value net of borrowings, falls. If it falls below the maintenance margin, the crypto broker will liquidate your positions to protect your lender’s capital.
You can always choose how much margin to employ. With Bitmex, the slider function allows you to increase or decrease leverage, according to your preferences:
You will also be able to see at what rate you are borrowing at and the fees payable to execute the trade:
As a margin trading account holder, you are also in the position to profit by lending your Bitcoin or Altcoins to other traders. You will be able to see existing loan offers from other exchange users and their respective loan rates:
Although not technically considered to be margin trading, other instruments allow you to invest in crypto with leverage. These are:
- Contracts for Difference (CFDs)
A CFD is a financial instrument that reflects the movements of the underlying asset. The asset itself is never owned, but the account realizes the profits and losses generated by the underlying movement. The CFD contract occurs between the trader and the brokerage firm. CFDs on cryptos offer significant leverage, up to a level of 50 to 1.
Futures are instead fixed-term contracts for the delivery of a certain asset. The price is fixed at the time of the trade, with profits and losses calculated based on the entry price. Options are also contracts that give the owner the right to buy (Call option), or sell (Put option), an asset at a certain fixed price (the “strike”) and by a certain date. A Call option on Bitcoin with a strike price at $15,000 would be worth $5,000 at expiration if the price reached $20,000. It would however expire worthless if the price were to remain at $15,000 or below. The first Bitcoin options and futures started trading in December 2017 on the CBOE, with significant success to date.
The Advantages & Disadvantages Of Margin Trading
When trading on margin, the main factor that has to be considered is that of risk. Leveraged positions, when they go against you, can cause significant losses to your portfolio in very little time. This is more so the case in crypto where double-digit percentage moves in the space of 24 hours are not uncommon. If you are leveraged 20:1, a 5% move against you can mean losing 100% of your account value.
To avoid this, the most advisable strategies to adopt are:
- Position Sizing
- Stop Losses
- Low Leverage
Position sizing simply means choosing what percentage of your account you want to invest in a specific crypto currency. By limiting size, you naturally limit your potential profits, but also your chances of a major blowup. For example, if you put 10% of your account into Bitcoin with 5:1 leverage, you are actually only risking 2% of your total account value.
The second main strategy is using stop losses. These are automated orders where your investment is liquidated when a certain price point is reached. For example, you could buy Ethereum with a 10% trailing stop loss at market price. That means that if Ethereum price goes against your long/short, your position is sold at a price level that represents 10% loss to protect further losses. You can also choose a trailing stop based on fixed monetary value, rather than a percentage value. Your account screen it will look like this:
Other stop losses may be put at predetermined prices, for example buying Bitcoin at $15,000 with a stop loss at $14,000. That means that you are risking a maximum of $1,000, even if Bitcoin’s price falls below $14,000. Stop losses allow you to measure the risk you take in precise and measurable terms, so you can better manage your portfolio.
The third and final strategy is using low leverage on the trades you do execute. This ensures that when small price fluctuations do occur in the opposite direction of your intended trade direction, you’re not forced to execute stop losses or forced to reconsider your position bias during short term fluctuations.
Final Thoughts – To Trade Or Not To Trade On Margin?
When unleveraged crypto accounts are able to earn triple and quadruple-digit percentage returns in the space of months, margin trading could seem to be redundant. After all, the returns are already significant without having to add an extra element of risk. Recent volatility in crypto however once again shows that trading, to be effective, has to be flexible. That means the capacity of both going long and short, and using leverage in an intelligent way. Before doing this, however, the first step is finding a trading strategy that is effective, fits your risk tolerance and your investment objectives. Once this has been done, margin trading will accelerate and amplify a trader’s long-term profitability and overall success if done correctly.