For traders with a limited amount of crypto resources, i.e. Bitcoin and altcoins, there is the option of margin trading in order to add leverage to the investment. This, in fact, increases the amount invested without having to actually hold the assets. It is important to mention that margin trading is not recommended for everyone and it has a very high risk.
Let’s start: What is Margin Trading?
Margin trading allows a trader to open a position with leverage. For example – we opened a margin position with 2X leverage. Our base assets had increased by 10%. Our position yielded 20% because of the 2X leverage. Standard trades are traded with leverage of 1:1.
Margin trading is possible due to the existence of the lending market. Lenders provide loans to traders so they can invest in larger amounts of coins, and lenders benefit from interest on the loans. In some exchanges, like Poloniex, users provide the loans for the margin markets and in others the exchange itself provides them. For example, in the Poloniex exchange anyone can lend their bitcoins or altcoins and benefit from interest on the loan. The main disadvantage is that the coins need to be in the exchange’s wallet, which is a lot less secure than a cold wallet.
Costs and risks of margin trading
As mentioned above, the cost of the margin position includes paying the interest for the borrowed coins (whether to the exchange or to other users), and fees for opening a position with the exchange. As the chance to earn more increases, so does the risk to lose more. The maximum we can lose is the amount we invested in order to open the position. This level is called the liquidation value. The liquidation value is the value where the exchange would automatically close our position so we won’t lose any of the loaned money, and only lose our own money.
Example: if we are talking about standard trading, leverage 1:1, the liquidation value is when the position reaches a value of zero. As the leverage increases, the liquidation value will get closer to our buying price. For example, Bitcoin value is $1,000, we bought one Bitcoin (long) with leverage of 2:1. The cost of our position is 1000 USD, in addition we borrowed 1000 more USD. The liquidation value of our position will be a little over 500 USD – because at that level we lose exactly our initial 1000 USD plus interest and fees. Margin trading can also be against the market, we can also short position with leverage.
Margin trading tips
Risk Management – When trading on margin it is important that there are clear rules of risk management, beware of excessive greed. Take into account the amount you are willing to risk, keeping in mind it can be lost completely. Set clear levels for closing positions, taking profit or a stop loss.
Watch closely – Crypto coins are considered assets with excessive volatility. Margin trading of crypto currencies doubles the risk. Therefore try to make short-term trading leveraged positions. Moreover, although the daily fees or margin position is negligible, in the long term the fees can amount to a significant sum.
Extreme movements – Crypto trading sometimes has extreme fluctuations that occur in both directions (“Deep”). The risk in this case is that the deep will touch our liquidation value. It could happen where the leverage is relatively high so the liquidation value is relatively close. In fact you can take advantage of these deeps and try to set closing target positions, hoping the deep will run over them, leaving you with a decent profit and then going back to the previous price. Additional tips for trading Bitcoin and Altcoins – can be read here and here.
