When you are trading cryptocurrencies with margin it means you are adding leverage to your position by borrowing money to increase the size of your trade. The funds borrowed may come from the exchange itself, or it may come from an outside lender, or it could be a peer-to-peer lending solution. It is typically necessary to pay interest on the funds borrowed to trade on margin as well.
For example, suppose you want to buy $10,000 worth of Bitcoin, but you only have $2,000. You could leverage 5:1 and borrow $8,000 to purchase the full $10k. You will have to pay back the $8,000 borrowed, plus interest and fees, but that’s not a concern if your trade goes well and you profit.
On the other hand, if the trade goes poorly you could be targeted with a margin call. This is when the lender forces you to liquidate your position to ensure you’re able to pay back their loan and the associated interest and fees. You can usually avoid a margin call by adding more of your own money to the position.
Most exchanges will offer a range of leverage amounts from as low as 2:1 to as high as 400:1 (although such high leverage is usually reserved for assets other than cryptocurrencies). You can use margin to go long, or to go short. It can also be used to hedge or to simply avoid keeping all of your own coins in the exchange wallet.
The rest of this article will be given over to teach you the basics of margin trading, to warn of the risks involved, and the share some useful tips regarding margin trading.
Where to Margin Trade Cryptocurrencies
As recently as several months ago it was difficult to find cryptocurrency exchanges who offered margin trading, but that has rapidly changed as they are all scrambling to remain competitive with one another. Some of the largest exchanges that offer margin trading include Bitfinex, Poloniex, Kraken and Bitmex.
Before you register at an exchange and deposit be sure to check their terms and conditions. Some exchanges have strigent criteria for who they will allow to trade on margin. Others are more flexible and allow anyone with the funds to trade on margin if they wish to do so.
For example, Coinbase Pro (formerly GDAX) only allows accredited investors access to margin trading. By contrast, Kraken allows all of their Tier 1 – 4 clients margin trading.
Also be sure to check your account settings if you register at an exchange that allows margin trading. Some exchanges will have margin trading privileges active by default. If that’s the case you may want to deactivate this feature until you gain some experience trading. Otherwise you could end up using margin before you’re ready, and lose big time.
Margin Trading – Leverage
Now that you have some basics about margin trading covered let’s go into more detail. First I want to discuss leverage.
In its most basic form margin trading is borrowing funds to leverage your bet, or make it larger. This can be a good strategy if the odds are in your favor, since it can amplify your profits. But it also amplifies losses, which is something many new traders fail to consider.
Take our example from above. With 5:1 leverage you can use margin trading to control $10,000 worth of cryptocurrencies with only $2,000 of your own money. The other $8,000 is borrowed from the exchange or some other lender.
Typically there are fees and interest associated with the loan, and of course you need to pay back the loan at some time.
Margin Trading Call Prices and Liquidation
Everything is all well and good if the price goes up as you’re hoping. If that $10,000 bet increases by 20% you now have $12,000. You can pay back the $8,000 borrowed and still have $4,000 left. That means you actually doubled your own money with that 20% gain (less fees and interest).
But what it the price remains stagnant and doesn’t change? You’ll still be on the hook for interest charges, and usually those are taken each day. That can really add up if it lasts for very long.
And even worse, what if the price falls 20%?
When the price drops enough that your remaining balance is near the amount you’ve borrowed you’re going to be in trouble. Margin lenders consider this the “Maintenance Margin Requirement (MMR) and if you reach this level a margin call is imminent.
Now your $10,000 is worth just $8,000 and you’re going to be faced with a margin call, because the lender will want to be sure they get their money back. If you get hit with a margin call you’ll be left with nothing, even though the price only fell by 20%.
Here’s a tip: A margin call can be offset by depositing more money and contributing them to the order you’re getting the margin call from. This increases your margin ratio, but it can also be chasing a loser in some cases.
Basically margin trading allows you to make bigger bets than you’d normally be able to do. This comes with added risk and additional fees, and if you aren’t careful you could end up losing it all.
Bottom line – Be very careful when using margin. Use it sparingly and only when the odds are strongly in your favor.
Pro Tip: Consider using stops to protect yourself from the possibility of a margin call. You can also consider hedging your position with another position, but this is an advanced technique and should be used carefully. If you learn proper technical analysis and risk management you can effectively reduce the risks from margin trading dramatically.
Should I Trade Cryptocurrencies with Margin?
If you’re new to cryptocurrencies, and especially if you’re new to trading it is highly recommended that you avoid using margin. The possible exceptions to this are if you’ve already done extensive research or if you’re using margin specifically for hedging. Remember that trading cryptocurrencies can be stressful enough if you suffer a loss without magnifying that by using margin. That also magnifies your stress level.
If you’re dead set on using margin in your trading the best thing you can do is to read as much as possible on the use of margin before starting. That also applies to your chosen exchange, where you should learn how to open and close margin positions and what the margin ratios are and when you’ll be subject to calls. It’s assumed that you’re already well versed in technical indicators and trading using them, but you should also develop a margin trading strategy.
Pro Tip: If you aren’t already intimately familiar with technical indicators and trading with them take the time to familiarize yourself before using margin. Blindly trading is a surefire recipe for disaster and any pro will tell you not to speculate blindly, and especially not when leverage is involved.
More Risk Warnings
Some people have said that CFDs, binary options and even simple forex trading is risky. But margin trading volatile cryptocurrencies is possibly the riskiest bet you can make. Volatile cryptocurrencies are risky and margin trading alone is risky, but when you combine them you have a potentially lethal combination to your equity. One bad trade on a highly volatile altcoin could see you losing it all and even falling into debt.
It’s important to understand that not only can you lose everything when trading on margin, you can also lose it far faster when using leverage. As I mentioned above, using 5:1 leverage only needs your position to lose 20% before you’re wiped out. That’s not a large move at all in the world of cryptocurrencies.
Look at it this way. If you’re using 5:1 leverage on a $1,000 trade you actually only have $200 to lose. If the price goes up you can double your money quickly, but if the price goes down you can lose it all just as quickly. The more leverage you use, the faster you can see a margin call if the position goes against you.
Even worse, you could see the position move against you enough for a margin call that wipes you out, and then turn around and head to the moon.
Tip: If you hold a lot of cryptocurrency using margin may be a good way to avoid keeping it all in an exchange wallet, where it is vulnerable to hackers. Instead you can keep your own coins offline in cold storage and use margin to trade with. This removes at least some of the risk associated with leveraged trading since you do have the funds to cover losses, or to cover a margin call. The downside is that you could still have a position liquidated unexpectedly during a downturn. When you hold cryptocurrency long-term it doesn’t matter too much what price does, but if you’re using margin a short-term drop in price can force a margin call and lost money.
Margin Trading and Taxes
If you decide to margin trade you’re going to be making small capital gains and losses constantly. In the U.S. at least this makes you subject to short-term capital gains taxes as well as the requirement to report your trades and pay taxes quarterly. This might make simply holding cryptocurrencies for the long term more attractive, since the long-term capital gains rate is far less, and the reporting burden is also less. It’s just one more thing to consider if you want to start margin trading cryptocurrencies.
In Conclusion
Margin trading is an exciting and risky way to get involved in the cryptocurrency markets. There’s great profit potential, but also huge risk for the unwary. Anyone thinking of using margin in their cryptocurrency trading should be sure they already have a solid base of trading and technical analysis, as well as a strong personality to ride out the inevitable volatility.
If you aren’t already an experienced trader you may want to take a slower approach to margin trading. Learn all you can about it, learn as much as possible about technical analysis of price action, and develop a margin trading strategy. This might not guarantee you’ll avoid a margin call, but it will certainly make it less likely.
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