Margin Trading, Explained
So… what is margin trading?
This is where you make trades using money borrowed from someone else – or a brokerage.
While the potential rewards can be high, there are some sizeable risks that investors need to contend with too.
Let’s start with an example using dollars. Imagine you have $50. Margin trading is where you leverage $500 based on this sum of money in your pocket.
As you’d imagine, the principle in the cryptocurrency world is quite similar. Let’s say you want to buy Ethereum worth $1,000, but you’ve only got $500 available. Through margin trading, you’d be able to borrow an extra $500 – getting you up to the magic total.
If your $1,000 in Ethereum grew in value, to say $1,500, you’d be able to liquidate it and return the $500 to the lender, leaving you with a gross profit of $500.
Of course, the value of cryptocurrencies can go dramatically down as well as up. In a scenario where the price of Ethereum went down by 50 percent, your lender would be able to get their $500 first before you can access funds, potentially leaving you with nothing.
I’ve heard of long and short positions. What are they?
These two terms relate to whether a trader thinks a cryptocurrency is going to rise or fall in value.
“Going long” generally means that you believe the Bitcoin or Ethereum you’ve just purchased will rise in value over time – and through leveraging, this can amplify your gains (and amplify any losses you make.)
On the flipside, you might believe that one of these cryptocurrencies is about to experience a fall in value – and this is where a short position comes in handy. As an example, let’s imagine you think that Bitcoin, trading at $7,000, is going to drop in price. Here, you sell your Bitcoin for $7,000 – and then buy it back when it tumbles to $6,400. Once this transaction has been completed, this represents a gain of $600.
What are the most common risks with margin trading?
The fact that many cryptocurrencies are so volatile means margin trading is only recommended if you’ve done your homework and have experience.
Losing your own money when trading in crypto can be unpleasant enough without the borrowed funds of other investors coming into the equation.
The main risk to remember is that you have the potential to lose your whole initial investment through margin trading, especially if your focus has been on altcoins with a low volume and high volatility.
If one of your trades starts to lose money, your margin can be “called in.” Let’s say you are margin trading with a ratio of 2:1, where every dollar you’re investing is matched by someone else. Here, your position would be liquidated when the value falls by about 50 percent in order to preserve the lender’s funds.
It is possible to inject further cash to prevent this from happening, but this can cause substantial losses to pile up quickly. Sometimes, it’s about knowing when to cut your losses.
Are margin trades regulated?
They are regulated with uniformity on conventional stock exchanges – but the rules can vary between crypto platforms.
This may all be about to change. For example, as reported by Cointelegraph, Japan’s Virtual Currency Exchange Association (JVCEA) wants to limit the amount that margin traders can borrow – enforcing a cap that stands at four times the amount of their investment.
Explaining their plan to a Chinese media outlet, the JVCEA said: “It aims to prevent investors from suffering a lot of losses due to sudden price fluctuation of the virtual currency.”
Regulatory compliance has become something of a priority after the Coincheck exchange was a victim of a massive hack back in January, with 523 million NEM coins worth $534 million being lost back in January.
Other major exchanges, such as OKEx, already cap leveraging to three times the amount of capital that an investor has. Kraken offers up to five times leverage, but only to users who have verified their identity. The number of pairings it offers is currently restricted, and pairings involving euros are not available in some US states.
Coinsbit, a new trading platform, is also planning to introduce margin trading by the end of the year — along with crypto loans in U.S. dollars.
As with the above-mentioned examples, Coinsbit is planning to set certain rules and limitations on margin trading. It will be made in order to protect users and their financial assets. Coinsbit says it relies on the experience of other trading platforms and wants to provide traders with the best possible service, but at the same time, make sure that personal information, as well as finances, are secured. The platform already uses the Know Your Customer (KYC) procedure. The exchange gathers complete information about their clients in order to prevent fraud and illegal transactions.
Any tips for getting the best results?
First and foremost, remember that it’s your money at stake.
Generally, margin trading should be considered as a short-term investment – not least because of the wild volatility that often grips the crypto market.
You should never invest more than you can afford to lose, and it’s always worth setting limits that will automatically pull you out of an investment whenever it falls below a certain level. Similarly, setting profit targets also ensures that you exit a trade at the optimal time.
Once again, this is an advanced activity that should not be entered into lightly.
You should always factor in any costs that may arise as part of your margin trading – such as platform fees and interest rates to lenders – and it’s always worth gaining experience and confidence through trading with your own money first.
Is margin trading available on all crypto exchanges?
Most of them – but not all.
As we mentioned earlier, the likes of OKEx and Kraken have rolled out this feature, but some of the bigger crypto exchanges such as Binance do not offer margin trading at present. Huobi activated margin trading back at the start of 2018, and this service is also available through HitBTC, Bitfinex and Bithumb.
Cointelegraph recently reported that Bakkt, the upcoming regulated ecosystem for crypto assets around the world, will also not support margin trading – and says its platform is meant to ensure that “the buying and selling of Bitcoin is fully collateralized or pre-funded.”
Coinsbit is hoping to stand out from the hundreds of other exchanges by tackling the security and liquidity concerns that traders face, as well as high transaction fees. More than 95 percent of all currency is stored in cold wallets. Web Application Firewall (WAF) — a protective screen of a web application — detects and blocks hacker attacks. Coinsbit is currently working to get listed on CoinMarketCap.
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