Sign UpWhat Is Margin Trading?
Beginner
2024-09-21
Margin trading is a type of trading where traders use borrowed funds in order to purchase derivatives, bonds, and stocks. However, the important part of margin trading is that traders need to have a percentage of the funds themselves. This is because in order for margin trading to work, the trader needs to make the purchase alone but does not require the entire amount as they use a “margin” to settle up the remainder.
Currently, the minimum amount of funds required is 50% of the total value of the purchase, which is better known as the initial margin.
What Is Margin Trading in Crypto?
In crypto, margin trading works by borrowing funds from exchanges. Then, after acquiring those funds, crypto trader would use that to buy more tokens or to trade what they already have.
Here are some terms that are typically used when margin trading in crypto:
Margin Account
Traders can open a margin account on a cryptocurrency exchange. Then, with this account that they opened, it allows them to borrow funds based on their existing capital to enter into even larger positions.
Leverage
Leverage is the ratio of borrowed funds to the user's own capital. For example, if you use 2x leverage, you can control a position worth twice your actual capital. Common leverage levels in crypto margin trading range from 2x to 100x, but it is important to note that high leverage also increases the risk of significant losses.
Long and Short Positions
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Long Position: A trader expects the value of a cryptocurrency to rise. They borrow funds to buy the asset, aiming to sell it later at a higher price and repay the borrowed amount.
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Short Position: A trader expects the value of a cryptocurrency to fall. They borrow the asset, sell it at the current price, and aim to buy it back later at a lower price to repay the borrowed amount.
Interest and Fees
Users typically pay interest in the borrowed funds, and there may be additional fees associated with margin trading. These costs can impact the overall profitability of the trade a user is making.
Liquidation
If the market moves against the user and their losses approach the borrowed amount, the exchange may automatically close the position to prevent any further losses. This process is known as liquidation and is crucial to any trader.
It is very important for users who are interested and thinking of engaging in margin trading to have a good understanding of the risks involved in it. Losses can even exceed the initial capital, so traders must perform their own research before making informed decisions.
How To Margin Trade?
Here's a step-by-step explanation of how margin trading works:
Open a Margin Account
Traders first need to open a margin account with a broker or an exchange, like Toobit. This account that they have created now allows them to borrow funds against their existing capital.
Deposit Initial Margin
Next, traders must deposit an initial margin (a percentage of the total trade value) that is determined by the broker. The initial margin serves as collateral for the borrowed funds.
Choose Your Leverage
Leverage is the ratio of the borrowed amount to the trader's own capital. For example, with 2x leverage, a trader can control a position worth twice their initial margin. Leverage amplifies both potential profits and losses.
Enter a Long or Short Position
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For long positions, a trader will expect the asset's price to rise, so they go long. They will borrow funds to buy the asset, aiming to sell it later at a higher price.
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For short positions, a trader will expect the asset's price to fall, so they go short. They will borrow the asset, sell it at the current price, and aim to buy it back later at a lower price.
Monitoring and Maintenance
Furthermore, traders need to monitor their positions regularly. If the market moves against them, the value of the position may fall, bringing them closer to a margin call. This applies even more so when trading in crypto.
Interest and Fees
Traders must pay interest on the borrowed funds. The interest rate and fees will depend on the broker and may differ per trade. It's essential to factor in these costs when assessing the overall profitability of a trade.
Margin Calls and Liquidation
If the value of the position is coming close to the total value of the trader's account (maintenance margin), your broker may issue a margin call. The trader now has two options; either deposit additional funds or close some positions. If the trader fails to do either of the options, your broker may liquidate the positions to cover any losses.
Closing the Position
Lastly, traders can close their positions at any time. If the trade is profitable, they sell the asset (in a long position) or buy it back (in a short position) to repay the borrowed funds and take their profits.
The double edged sword of margin trading is that it can significantly magnify both gains and losses, making it a high-risk strategy. Traders who want to margin trade require a solid understanding of the market, risk management principles, as well as the terms and conditions set by their broker in order to engage in margin trading successfully.
What are the Advantages of Margin Trading?
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Better purchasing power
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Bigger chance to magnify wins
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Basically trading with leverage
What are the Disadvantages of Margin Trading?
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Requires a lot of funds
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Heavy losses
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Requires a lot of dedication
Closing Thoughts
Margin trading may increase your profits--but it can also seriously increase your losses. Margin trading is better suited for more experienced traders or traders with less risk, but we at Toobit encourage all our users to experiment with different types of trading until they find what suits them best. We also would like to stress that educating yourself as a trader is key, and to always be responsible when trading. All the best, trader!
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