What Is Margin Trading
What Is Margin Trading?
Margin trading in crypto provides you with leverage, allowing you to borrow funds to take on larger positions while only using a small amount of your own capital. With margin trading, you are able to access a larger trading capital than what you possess, thereby potentially amplifying your potential profits (or losses).
By putting up a certain percentage of your total position value as collateral, also known as margin, you can borrow additional funds to take up larger positions. This allows you to trade larger volumes and take advantage of market opportunities even if you do not have sufficient funds on hand.
How Margin Trading Works?
Margin trading is similar to how borrowing money works.
Let’s assume that you want to buy a house that costs $500,000, but you only have $100,000. So you approach a bank to loan you the remaining $400,000. The bank agrees to loan you the money so now you have the full $500,000 to buy the house. In margin trading, the exchange that you trade with will typically provide you with a margin loan.
But the bank does not loan you the money for free. Instead, they will charge an interest on that loan say 5%. In margin trading, the exchange will typically charge you a fee based on its margin rates.
With the borrowed funds, you now have the $500,000 to buy the house. If the price of your house goes up and is now worth $600,000, you can sell it, and with the $600,000, you can pay back the bank’s $420,000 ($400,000 x 105%) and keep the remaining $180,000. You would have made $80,000 in profit based on your initial $100,000, giving you an 80% profit. That is how you make money with margin trading.
But if the price of your house goes down to $450,000, and you sell it, you will still need to pay back the $400,000 to the bank leaving you with only $50,000 left. This means that you will have lost $50,000 ($100,000 – $50,000).
With the right use of margin trading, you can amplify your gains. But the wrong use can make you lose money. That is why it is important to have a proper foundation and understanding before getting into margin trading.
Margin Trading Example
When you trade on the Flipster app, you can use up to 50x leverage on all financial instruments.
Let’s say you believe that the price of BTC will go up. You have $10,000 in your account but you want to take a larger position to potentially maximize your profit.
With margin trading, you can use leverage to open a larger position than what you have available in your account. Assume that you choose to use 5x leverage. In this case, you would be able to leverage your $10,000 by a factor of 5, resulting in a total trading capital of $50,000.
With the 5x leverage, you are now able to open a position worth $50,000 in BTC. If the price of BTC increase, your potential profits are amplified by 5x, giving you a higher return on investment compared to using only your initial $10,000.
If BTC falls instead, your potential losses would also be amplified. If your position starts to approach the margin limit, you will have to deposit additional funds to maintain your position or risk getting liquidated.
Margin Modes
Cross Margin
Cross margin is a margin mode used in trading that allows you to use your whole account balance as collateral for multiple open positions. So excess margin from one open position can be shared or transferred to another open position to satisfy maintenance margin requirements.
In other words, available margin across all of your open positions are considered collectively. This means that any realized/unrealized profit and losses from other positions are used to support the open positions.
The advantage of cross margin is that it provides you with more flexibility when managing your margin requirements. It allows you to utilize your available margin in your account across multiple positions which reduces the likelihood of margin calls and liquidation.
While cross margin provides increased flexibility, it also carries its own risks. Since your whole account balance is used as collateral and shared among all your positions, losses in one position can impact the margin availability for your other positions.
Isolated Margin
Isolated margin is a margin mode which restricts margin to be used only for that specific open position. Unlike cross margin, with isolated margin, each open position is treated independently with its own allocated margin. Gains or losses from other positions do not affect the margin requirement for that specific position.
The advantage of isolated margin is that it allows you to isolate risk and manage your positions separately. Losses in one position do not directly impact the margin availability for your other open positions.
As margin for a position is allocated individually and separate from other open positions for isolated margin, you need to ensure that you allocate sufficient margin to each position. If the margin allocated to a certain position falls below the required level, your position may be liquidated.
Types Of Margin
Initial Margin
Initial margin refers to the minimum amount of collateral or funds that you are required to post upfront before initiating a new position. This acts as insurance for the exchange to ensure that you have sufficient capital to cover potential losses.
The initial margin is typically a percentage of your total position value. This amount can differ based on different cryptocurrencies and the leverage offered by the exchange.
Maintenance Margin
Maintenance Margin is the minimum amount of funds that you must maintain in your margin account to keep your existing position open. The maintenance margin is a predetermined amount set by the exchange to ensure that you have enough capital to cover potential losses during market fluctuations.
To avoid liquidation and getting a margin call, you have to ensure that your account value remains above the maintenance margin level.
What Is Margin Call
Margin call in crypto trading happens when your account value falls below the margin level required by the exchange. The exchange will notify you to deposit additional funds into your trading account to meet the minimum margin requirements.
The purpose of a margin call is to ensure that you have sufficient funds to cover potential losses and maintain the required margin levels in your account.
Advantages & Disadvantages of Margin Trading
Advantages
1. Increase buying power
Margin trading allows you to take a larger position than you would not be able to with your funds alone.
2. Amplify your gains
With the increased buying power that margin trading provides, it also allows you to amplify your potential profits.
3. Increase your ability to diversify
Using just your own capital, you might be able to only trade up to a certain number of crypto. By using leverage (margin trading), you will be able to trade a larger number of crypto and potentially spread out your risk and diversify your portfolio.
Disadvantages
- Amplify your losses
While margin trading can potentially amplify your gains, if prices go against you, it could also lead to higher losses. The use of leverage can amplify both profits and losses.
- Margin call/Liquidation
Margin trading requires you to maintain a minimum level of margin to sustain your open position(s). If your account value falls below the required margin level, you may receive a margin call or your position may get liquidated, resulting in potential losses.
Now that you have learned about margin trading and how to use it, supercharge your trading potential with the Flipster app with zero trading fees and over 180+ tokens to trade from. Don’t miss out on this opportunity to take your crypto trading to the next level. Download the Flipster app today!
Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service.
Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.