How To Use Leverage: Cryptocurrency Margin Trading Explained

August 2, 2021
5m
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Margin trading, otherwise known as leveraged trading, is the act of borrowing funds from an exchange or broker to increase one’s position. Leveraged trades are a common practice among beginners and experienced traders alike, as they look to increase their wealth faster than what can be achieved with standard trading and investing.

A common instance of margin trading is using a 10x leverage. Effectively, this means increasing your original order by a magnitude of ten. With a $1,000 investment, margin trading allows us to open a position as if we had $10,000. Therefore, any profit that we make is increased tenfold once the position is closed.

However, this advantage does not come without risks. Leveraged positions liquidate an account, specifically its original order, if the trade ventures into the opposite direction. A long position on Bitcoin with 10x leverage opened at $35,000 will be liquidated once the price of $32,000 is reached. Likewise, a similar short position will face liquidation at approximately $38,600.

Considering that cryptocurrencies are a highly volatile market, even the slightest use of leverage should not be taken lightly. That is why our goal with this lesson is to figure out the intricacies of margin trading.

What is crypto margin trading?

Whether you are margin trading with Bitcoin, Ethereum, or another supported cryptocurrency, the framework is the same. Margin trading refers to depositing an amount of collateral (either crypto or fiat currency), using that collateral to receive a loan, then trading with the larger loaned amount.

Trading larger positions provides you with the opportunity to earn more money. Price movements net larger profits when trading with a greater position size than they do when your size is smaller.

The major aspect of margin trading is that exposure goes both ways. Although margin trading enables you to win bigger, it also makes it easier and faster to lose.

How crypto margin trading works

Trading cryptocurrencies on margin all begins with depositing a percentage of the total position size as collateral. This amount is often deposited in the traded asset (in-kind) but may also be paid in stablecoins or fiat, depending on the trading platform.

The deposited amount is known as your margin. This margin forms the basis of your leveraged position, which is the amount of financial power that you are trading with using your margin.

The amount of margin needed for a given leveraged position depends entirely on the amount of leverage, expressed as a ratio; you’re trading with. For instance, if you decide to open a 10:1 (alternatively 10x) leveraged Bitcoin long with a $10,000 position size, you will need to have $1,000 deposited in your account as margin.

Determining the initial capital needed for a given position size is simply done based on the ratio that is used. Another popular way to express the ratio in leveraged trading is 2x (2:1), 5x (5:1), 10x(10:1), and so on.

There are two directions you take a position on during a leveraged crypto trade: up or down. If you believe the price direction is heading up, you open a leveraged long. For betting on downward price volatility, a leveraged short is what you will need.

Understanding margin calls

We can anticipate an asset’s price action, but we rarely ever predict it correctly. This is where the risk of margin trading steps in.

If price direction moves against your position quickly, you need to rapidly deposit more collateral in your margin account or risk a margin call.

A margin call means that the exchange liquidates the collateral in your account to cover your trading losses. When the price moves against your trade, the exchange moves quickly to cover itself by ensuring it pays back the full amount of the margin loan lest your losses exceed that value.

Trading platforms will alert you when your account is getting dangerously close to being liquidated. At this point, you can either add more collateral, thus giving your trade a lease on life, or you can do nothing.

If you do nothing, your position will be liquidated. As a result, adding more collateral might be the better option. By giving your account additional funding, you might save your account from complete annihilation or even save time long enough to see the trade play out in the end.

To avoid having your leveraged crypto trade get liquidated, the key is to trade with responsible size (do not trade more than you can afford to lose) and always trade with a stop loss in place.

By trading without stop-loss orders, you are effectively being okay with having your position liquidated. A stop-loss ensures that you only lose 5% or 10%, but a liquidation assures a 100% loss.

Know what your limits are and when to cut off losing positions. There is no trader with a 100% win rate, so keep that in mind while managing your positions.

Pros and cons of margin trading cryptocurrencies

If you are still on the fence about whether margin trading with cryptocurrencies is for you, use these pros and cons to help you decide.

Pros:

  • Greater exposure to price volatility means more profits when you get the market right.
  • Traders with plenty of technical analysis ability can put their skills to the test.
  • Knowing how to manage risks with stop losses makes margin trading less dangerous.

Cons:

  • Greater exposure to price volatility means more losses when you get the market wrong.
  • Unlike spot trading, margin trading is not set it and forget it.
  • Only recommended for people with lots of time to babysit their open trades.
  • Beginners with little trading experience are easily liquidated.

Ultimately, crypto margin trading is best left to experienced traders who have deep technical analysis knowledge, enough funds on hand to bounce back from losses, and have plenty of time to commit to crypto trading.

Those who trade casually or do not have the time to invest in learning TA should preferably paper trade first or stick with basic investing strategies like HODLing.