Margin is a loan with an interest rate and collateral, both of which are set by the broker. The margin interest rate depends on the amount you borrow and the relationship with the broker.
Cash and stock are popular forms of collateral commonly used by margin traders, depending on account size and the type of securities being traded. Traders must also maintain a margin balance (called maintenance margin) in their account to cover losses.
Why Do Margin Trading?
Fundamentally why is it necessary to trade on margin? The first is for short-term sales that have multiple profit potential. The second is to manage acceptable risk.
Short term sales mean that margin is usually used for short sales. When you sell a security for a short time, you are betting that the security’s price will fall at some point in the future.
This process is often referred to as “shorting.” Margin trading increases the size of short positions, thereby increasing profits. However, the opposite is also possible, if there is a problem with the transaction, the potential loss can be very large.
Meanwhile, managing risk is directed that traders also use margin as a risk management tool to minimize or protect their losses. For example, you could hedge a long-term bet on an asset’s price trajectory by selling a smaller amount of the same or a smaller asset.
For example, you have $10k in your trading account and your broker allows you to borrow up to 50 percent or $5k in margin. Your trading balance is $15 thousand. If the stock you bought goes up 10 percent, you might make $150. However, if the stock drops 10 percent, you will lose $150 or $50 more than if you had nothing to borrow.
Advantages and Disadvantages of Using Margin Trading
The most obvious advantage of margin trading is because the value of a relatively large trading position can bring greater profits. In addition, margin trading is also conducive to diversification, as traders can open multiple positions with relatively small investment capital.
Finally, having a margin account makes it easier for traders to open positions quickly without having to transfer large amounts of funds to their accounts.
Also, margin trading does have an obvious drawback, namely increasing losses in the same way as increasing profits. In contrast to regular spot trading, the possible loss from trading on margin exceeds the trader’s initial investment, so it is considered a high-risk trading method.
According to the amount of leverage involved in the transaction, even a small decrease in the market price can cause the trader to lose. Thus, it is important for investors who decide to use margin trading to adopt proper risk management strategies and risk mitigation tools such as stop-loss limit orders.
Margin Trading Using Cryptocurrency
Margin trading is inherently riskier than retail trading. However, when it comes to cryptocurrencies, the risks are even higher. Due to the high volatility in this market, cryptocurrency margin traders need to be very careful. Although, hedging and risk management strategies may be useful, margin trading is definitely not for beginners.
Being able to analyze charts, identify trends, and determine entry and exit points does not eliminate the risks involved in margin trading, but can help predict risks better and trade more effectively.
Thus, before making full use of cryptocurrency trading, it is recommended that users first have a keen understanding of technical analysis and gain rich experience in spot trading.
The things you need to pay attention to in doing margin trading in cryptocurrencies are as follows:
1. First, cryptocurrency asset classes are not globally regulated, which can put transactions at risk. For example, the cryptocurrency trading ban imposed by China in 2017 could destroy the value of your investment portfolio.
2. Second, cryptocurrencies and crypto tokens are a relatively new asset class, and their price fluctuations always follow unpredictable patterns, with little connection to the underlying technology or analytical principles of mainstream markets.
So, cryptocurrencies traded on margin can generate bigger profits and losses. Also, because of this fact, it is very important that only experienced traders can understand the risk management practices of margin trading.
3. Finally, trading on margin requires an in-depth understanding of the global cryptocurrency market. In fact, there are hundreds of cryptocurrency exchanges around the world. For well-known legitimate exchanges, there are many suspicious operations that cannot be trusted, and using them will result in loss of user funds.
So, before you fully consider trading on margin, especially before margin trading Bitcoins on cryptocurrency exchanges, it is important to thoroughly research the platform you choose to work with.
The final word
So, that was a brief discussion about margins in the cryptocurrency world. Hopefully this article can be one of your references to get started in the world of crypto trading. Hope it inspires!
Author: Muhammad Zaki Fajrul Haq
Follow me at @mzfajrulhaq (Instagram) or @ZakiFajrul (Twitter).