Margin trading can be a confusing phenomenon to wrap your head around. Hopefully by the end of my explanation you will have a good grasp of what it means, and how it compares to trading without margin/leverage. There are two types of margin positions you can take, short and long. For the sake of this article, we will focus on the long position.
To go 'long' basically means investing borrowed money into something that you believe will increase in price. As an example, let's say one bitcoin is worth 20,000USD and I believe the value will increase from there. As such, I decide to enter a margin long position of 10x leverage. A 10x margin allows me to control 10x the amount of money as I am willing to risk.
For simplicity's sake, let's assume I have the funds available to purchase only one bitcoin, 20,000USD. In this case, a 10x leveraged margin position would allow me to control 10 times this amount. This is enabled by a third party that can be either a broker, or an exchange. In either case, the 20,000USD I choose to risk, is matched by 180,000USD that is lent to me by the third party.
Once I open the margin position, I am invested with 1 Bitcoin which I was able to purchase with my own money, and 9 Bitcoins which I purchased with borrowed money. This puts the account's balance at 10 bitcoins in total. 10x the amount I was able to afford. If the value of the bitcoin goes up to 22,000USD, the account balance goes up to 220,000USD.
If I want to close the long position at this point, I must return the borrowed money, which was 180,000USD, since the lender must always get their money back. If I return the borrowed 180,000 then I am left with 40,000. This means that I was able to make 20,000 out of the 20,000 I invested. Had I not traded with a 10x leverage, I would have only profited 2000USD from the price of the bitcoin I purchased going up to 22,000USD. I made 100% profit from a 10% increase in price, due to trading at 10x leverage.
The above example might make you wonder why anyone would bother trading without margin, when there is so much more money to be made be using margin. As such, I will give an example which will illustrate the dangers of margin trading, and why you may want to think twice before opening a margin at such a high multiplier.
Let's go back to the same example. Bitcoin is 20,000USD per unit, and I only have 20,000USD to invest. I open a 10x margin position so that I can gain 10x on the price movement, since I am confident that it will increase in price. The account balance is therefore 200,000USD, 180,000USD of which is borrowed money. If the price of Bitcoin moves in the opposite direction as the one I was betting on, as in it drops by 10%, for example, the account balance becomes 180,000USD.
At this point, there is 180,000USD remaining, which is the amount of the money that I borrowed from either a broker or an exchange which acts as a broker of sorts. The broker always gets their money back, since this is a rule. Since they must get their money back, I must return the full account balance once it reaches 180,000USD. If they let me stay in the position at a lower price, they would be counting on me to fork up some extra cash beyond my original investment in order to return to them the amount which they lent me. Since I can not be trusted to do this if I am margin trading on Bitfinex or Bitmex, they will liquidate me. The same trade done without margin would only put me at a 10% lose, as opposed to a 100% loss on my original investment.
As seen above, a 10x margin would cause you to need to give back the full balance of an account once the price works against you by 10%, which would leave you with 0 money once the trade is forced-terminated. So, although a 10% price increase in Bitcoin from where you opened your long position may yield 100% returns, a 10% decrease in price would cause you to lose all of your money, which is not fun.
This was a simplified example of how a margin long actually works. In a more realistic example, I would get liquidated on a 10x margin before the price worked against me by 10%, since the exchange needs to collect their funds a little bit before the point where I would go into a state of needing to owe them money, just to ensure that they are able to sell out of the position at the same price that I entered it. The exchange must always get their money back.
The above example applies to any margin level. A 2x margin long would be simplified to represent a situation where you gain or lose 2x the amount that the price moves. A10% increase in price would yield a 20% gain, and a 10% decrease in price would lead to a 20% loss (50% decrease for liquidation on 2x margin).
I would not advise you to trade anything on margin until you are extremely comfortable with the price-action of the market, as well as with the fundamental process of opening and closing margin positions. Also, make sure you never invest more money than you are prepared to lose, because it is very easy to get liquidated while margin trading, especially with commodities as volatile as cryptocurrencies.
