The margin trading of cryptocurrency is very popular with traders, because it increases earnings several times without increasing investments. Alas, it has quite high risks like any income with a high potential profit. However, if you understand its features well, the risks can be minimized. We will describe these features in this article!
What is margin trading on a cryptocurrency exchange?
It differs from ordinary trading games in that the player speculates not only with his own assets, but also with borrowed funds, which he borrows from the stock exchange on the security of his assets.
He can buy and sell several times more cryptocurrency with the help of borrowed funds than he could do using only his capital. Consequently, the benefit from successful operations also increases proportionally – several times.
The name “margin trading” comes from the word “margin”, which in this case means a pledge. Margins are the player’s own funds, which he provides as collateral when taking a loan.
Suppose an investor has $ 100 and confidence that a certain cryptocurrency, for example, Litecoin, will grow. He wants to buy it now, so he can sell it more expensive and make a profit in the form of the difference between prices. However, for $ 100, he can buy only 1 litecoin (even less, but for clarity, let him be 1). This is too little.
Then he goes to a crypto-exchange with the possibility of margin trading and borrows money there. He takes them not from the stock exchange, but from another cryptoinvestor, who provides loans to everyone at a certain interest.
The interest is set mainly by the lender himself, deciding for himself how much he is willing to allow another person to use his assets. Because of this, the percentages differ for different exchanges and for different cryptocurrencies.
The maximum amount that a player in need of money can borrow from a lender is determined by the exchange. This amount is denoted by the term “leverage” and is indicated as a coefficient.
For example, a leverage of 1-1 indicates that a player can borrow as much from a lender as he has in his account. This is $ 100 in our example. Leverage 1-2 allows you to take the amount twice the amount that is in the account – in our case, $ 200. Leverage 1-3 will allow a player with $ 100 to take $ 300, and so on.
For the full amount of the loan, plus his own funds, the player can buy the said litecoins. That is, if at $ 100 he could buy 1 litecoin, then at $ 100 + employed $ 300 (with a leverage of 1-3) he could buy 4 litecoins.
If the price of Litecoin really grows, for example, by 20% and is therefore $ 120, the player will sell the purchased 4 coins for $ 480 and make a profit of $ 20 x 4, that is, $ 80. This 80 $ minus the exchange commission for the transaction (0.1-0.2%), the commission for taking the loan (also about 0.2%) and the interest on the loan he retains.
$ 100 – his initial funds – also remain in his account and he returns $ 300 to the creditor. Thus, the net profit will be $ 80 minus interest and commissions, probably a little more than $ 75.
Margin cryptocurrency trading: features
When the expectations of the player who took the loan are justified, the situation unfolds for the benefit of all after the successful transaction is closed, the player returns the funds to the lender with interest and remains at a profit. However, player’s expectations may not be justified.
For example, Litecoin from the above example may not grow by 20%, but fall by 20%. It turns out that the player bought 4 litecoins for $ 400, but can only sell for $ 320, that is, with a loss of $ 80.
The lender, of course, should not suffer from the fact that the player’s prediction has not come true. Therefore, as soon as the value of assets (both borrowed and own) of a player reaches the size of the loan with interest. That is the amount that the player must return to the lender, the exchange automatically closes all the player’s positions and returns the funds to the lender.
The amount returned to the lender includes a margin at the same time – the player’s funds that he originally had and which he provided as collateral. Thus, he loses, besides the occupied assets, also his own.
This situation is denoted by the concept of “margin call” from the English, margin call – “margin call”, “message about the approaching limit”. This was the name of a phone call from a broker to a client at a time when interaction between exchange participants took place by telephone.
To avoid this, the player can replenish his account, thus informing the exchange that he is ready for further price reductions (and still hopes to raise it after a recession). It can do nothing and wait for the automatic closing of the position.
Also, the difference between the margin trading and the usual one is that when buying a cryptocurrency without leverage the trader becomes its owner. He can withdraw it from the account, spend, and so on. When buying with a leverage, he can neither withdraw it nor the margin – the exchange does not allow him.
Cryptocurrency Margin Trading: Secrets of Success
Margin trading speculation strategies are no different from ordinary ones. A trader can open a short or long position if he expects that the cryptocurrency will fall or grow or borrow for dumping and dumping if he is confident in his abilities and success.
Just the risk in this case is more, because without a loan if it fails, it loses its own funds in the amount of x, and with the loan – in the amount of 2, 3 and so on, depending on the leverage.
This means that as soon as the price goes into an unfavorable direction for the trader and the losses on his account, taking into account the loan and the interest, amount to 20–30%, all assets acquired with the loan funds will be automatically put up for sale at the market price, and the loan with interest will be returned to the lender.
Thus, the trader’s losses will amount to 20–30% instead of 100%, which will occur during a margin call. Such an automatic order to sell (or buy) an asset at a limit price is called “stop loss”.
Sometimes a trader can be sure that after a fall, the rate of assets purchased with credit funds will rise again. Then he replenishes his account in advance with an amount that does not allow him to reach a margin call, for example, with the full amount of the taken credit or 50 to 70% of it.
So he eliminates the risk of automatic loss of funds during a margin call and quietly waits for the growth of cryptocurrency. However, it should be noted that this is a risky strategy and requires confidence in the appreciation of the course, which usually results from a thorough mathematical analysis of the market and is rarely based only on intuition.
The lender receives interest for each day of using the funds. The longer a player uses credit funds, the more he will have to pay the lender.
If the interest rate is high (it happens when the lender provides rare cryptocurrencies, for example) and the player takes a loan for too long, then the total deductions to the lender can be substantial.
Excessively volatile cryptocurrencies are dangerous for margin trading. Without a leverage, it makes sense to speculate with them, since their value after a strong fall can also increase dramatically. With leverage, their sharp drop or jump can also sharply trigger a margin call and even if a player replenishes the account, the likelihood of another achievement of the limit is not excluded.
Plus, the more leverage, the greater the risk. It does not matter that after the fall, the currency will increase if a margin call occurs, the player will automatically lose money.
However, currencies that hardly fluctuate are not suitable for margin trading. If the currency stays in place, the investor who bought it without leverage will not lose anything. A speculator who bought it with funds borrowed from a lender will be forced to deduct him interest on a loan.
For example, a trader may have 1 litecoin on his account, which at the time of taking a loan is worth $ 100. A trader takes a loan in dollars, intending to speculate on a third currency, for example, on Ethereum. Meanwhile, Litecoin in relation to the dollar is falling and now 1 litecoin in the trader’s account does not correspond to $ 100, but $ 90.
As a result, the size of the margin is automatically reduced and the margin call is approaching, although there may be no actual losses from the unsuccessful trading of the trader. Therefore, you need to pay attention to how much the price of all assets pledged as collateral corresponds to the price they had at the time of taking the loan.
Margin cryptocurrency trading: recommendations for novice traders
Summing up, we can say that for a player who knows exactly why he takes a loan, he knows how to calculate his risks and, of course, predict the situation on the cryptocurrency market, margin trading can be a source of good income in the absence of significant start-up capital.
On the other hand, the higher the size of loans, the higher the risks and this rule works everywhere. Therefore, a novice player needs to be careful not to follow to emotions and remember that greed in trading games is not the best policy.