What is Margin trading?
While trading cryptocurrencies, it’s common to use derivatives such as CFDs and futures contracts.
A Bitcoin CFD (Contract for Difference) is an agreement between two parties to exchange the value of the difference between the opening price and the closing price of the virtual currency. CFDs can be used to trade various cryptocurrencies regardless of their upward or downward directions. Future contracts in Ether, for example is an agreement to buy or sell a certain amount of Ether at a predetermined price at a specified time in the future.
Margin trading is a key concept for those who trade cryptocurrency derivatives. CFD and futures contracts traders would be unable to open trading positions without initial margin – the amount required when engaging in margin transactions.
What is Margin Trading and How Does it Work?
Buying or selling on margin involves using borrowed funds from your broker to trade more than what you would usually trade in regular trading conditions. Margin trading is therefore a suitable option for those who want to add leverage to their trading portfolio, as the funds allocated to their trading are increased without having to own the underlying asset.
How Does Margin Trading Work in Regards to Cryptocurrencies?
Let’s use Litecoin, the “little brother” of Bitcoin, launched in 2011, as an example.
When opening a position on Litecoin, the trader is expected to put a portion of its total value aside. If the value of your position on Litecoin falls below a certain level, this “portion”, also known as collateral, is used by the broker to recoup any losses.
Margin trading goes hand-in-hand with leverage. Leverage enables margin account holders to have increased buying power. Thanks to leverage, they are not required to pay the full price for a trade on Ethereum or Bitcoin Cash, for example.
Leverage is often displayed as a ratio. For instance, a leverage of 2:1 on Bitcoin Cash means you’ll be able to open a position that’s twice the value of your account. Let’s say you open a trading account with $50,000. With a leverage of 2:1, you can trade with $100,000.
Improving Your Margin and Leveraged Trading
Margin trading can be risky. It is therefore not recommended for all types of traders. There are however, a few guidelines to follow in order to better manage your positions while using leverage and margin trading.
- Always Apply Sound Money Management Rules – Traders are recommended to constantly use stop-loss and take-profit orders when margin trading with cryptocurrencies. Before entering the market, traders should determine where they want to exit the market and the maximum loss they’re willing to bear.
- Closely Monitor the Markets – Cryptocurrencies can be very volatile assets, meaning that prices of Bitcoin, Ethereum and others alike can fluctuate unexpectedly and rapidly with extreme movements.
- Choose Your Trading Style Wisely – Fees and interest on borrowed coins can quickly add up significantly and have a negative impact on your overall trading results. Before investing in cryptocurrencies, make sure you have devised an effective and secure trading plan. It’s also important that you consider the fees and cost of margin positions that you might potentially be faced with.
- Leverage Comes with Benefits as well as Risks – Greater market exposure can multiply your gains, as well as your risks. This is why it’s important that you use sound money management rules to protect your trading capital and enable you to continue trading.