Margin Trading: A Detailed Definition & Guide

As an experienced cryptocurrency trader or investor, you’ve probably already heard the term margin trading. So far, you have had to use your own funds to speculate, but what if you could amplify the amount you trade, in order to generate a higher return, faster? This, in essence, is the definition of margin trading.

Margin Trading Basics

Margin trading occurs when a crypto trader borrows funds from either a broker or an exchange to be able to purchase more digital assets. Several exchanges offer this service, including CEX and Kraken. Therefore, margin trading is similar to a short term loan, with the sole purpose of purchasing cryptocurrency.

This practice has been around for decades, used in traditional markets. Whilst the rules differ between industries, crypto margin trading is considered to be simpler and faster. When you start margin trading, depending on the broker or exchange you use, you will be required to put up the funds in your account as collateral. Once you sell the assets bought through margin trading, the proceeds are settled at the exchange or broker until the loan is fully paid off.

Earning a Profit

Not all cryptocurrencies can be traded marginally, and Bitcoin is, by far, the most popular currency for this practice. Exchanges obtain the funds necessary from the loan from various sources, including from other users who accept to loan out their own funds in exchange of interest. This is just one of the many ways users can earn a profit with crypto.

Traders must decide whether they believe that the value of the currency will rise or fall, and take a long or short position respectively. In order to assist traders, the best exchanges offer detailed charts and data. Another great tool is to follow cryptocurrency news.

A Practical Example

Imagine you plan to buy Bitcoin with Bitmex and because you believe the value of the currency will rise. You, therefore, open a long position on margin for €5,000 with 10:1 leverage. This leverage means you only need to provide €500 to make the €5,000 purchase. If your belief proves to be correct, and the value of Bitcoin rises above your purchase price, you get to hold all of the profits, minus the margin trading costs.

However, should the price fall up to a pre-determined position, the Bitcoin is sold and you lose your €500, but that’s all you lose. The higher the leverage (40:1 instead of 10:1), the easier to lose an investment, as there is less of a buffer if the price goes in the opposite direction than you predicted.

A Final Word of Caution

Margin trading is an exciting next level for any experienced cryptocurrency trader, however, you should not simply dive in. Start small, by investing a portion of your capital and by using top-notch exchanges. Opt for trades with smaller leverages and be ready for a learning experience where you might lose some or all of your funds.