What is Margin Trading: An Explained Ultimate Guide
Cryptocurrency is not only an emerging global payment method but also a popular way to earn money. While investing is perhaps the most popular option, thousands of people all over the world make a significant profit by trading crypto every day. The idea is quite simple: you buy crypto, its price goes up, you sell it, then count the gain.
The benefits of this way of earning money can be cosmic. According to CoinMarketCap’s official data, the daily trading volume of the top 10 cryptocurrencies alone amounts to $108 billion. However, the market is enormous, and the key is to make the right deal.
Trading is a game that can make the winners rich. Besides, it is a readily accessible business that anyone can enter: your neighbor may be making money trading, and you may not even know about it. All you need is to be familiar with the market rules and have some money for the first investment.
There it’s hard to make it to a higher level to obtain big deals. Sometimes a beginner trader can have an idea of how to make a big profit from one trade but doesn’t have enough money. In this case, there is an option to lend money inside a stock or an exchange and put it into assets. It is called margin trading.
What is Margin Trading
The mechanism is rather simple. A trader takes a loan from another trader or a broker and then uses it to make a deal. After the trade is closed, the trader returns the loan with interest. What remains after the trade is completed is the trader’s benefit from the operation. For a real-life example, consider a situation: you want to buy Bitcoin in order to sell it after several days (you expect the price to grow by that time). But you only have enough funds to buy 0,5 BTC, which is not a lot in the context of trading; what you could do is take a loan and, in the end, earn ten times more. You borrow funds and buy 5 BTC; after some time the price grows by 10%, you sell it and gain 0,5 BTC benefit. It is ten times more than what you could have made with your own assets. After you pay the loan interest of 0,1 BTC, what remains on your account is 0,4 BTC of pure income. In this scenario, 10 is the leverage coefficient. This parameter shows how many times more you can lend to make a deal you want.
However, it is essential to understand that you need to make a deposit for the loan — it should equal the leverage amount. It means you will need to deposit the 1/10 of the loan so the creditor can cover the losses if the market does not go in the direction you were anticipating. In that case, the creditor may remind you that your margin is decreasing; this is called the margin call. Basically, it is the broker’s tool to control their benefit if the trader’s position looks unprofitable. If the trader’s position keeps deteriorating, the supplier may forcefully close the position and sell the asset at the current rate in order to regain the lent money.
Here’s another example to make it all clear. Sam thinks that the ETH rate will increase by 20% in comparison with Bitcoin in the next seven days. He decides to make a trade but can only afford to buy 20 ETH with the funds he has. He uses the opportunity of the margin trade with 5-to-1 leverage. Sam makes a deposit with his assets and takes a 10% BTC loan to buy 100 ETH. After seven days, Ethereum gains 20%, after which Sam trades it back into BTC. He earns 20 ETH, which is five times higher than he could have initially made. He returned 110 ETH-worth of BTC and got 10 ETH of pure income. Therefore, Sam made a 50% benefit with his initial 20 ETH assets. But if ETH had started to lose positions in that period, Sam could have got a margin call requesting to return the loan. If he had decided to ignore it and the trade went on becoming a loss, the deal could be forced to be closed. 100 ETH of the loan with the 20 ETH of the deposit would be sold, and the funds transferred to the creditor. In that case, Sam would have lost the deposit.
Pros and Cons of Margin Trading
On the one hand, margin trading is an opportunity to engage in more significant deals. It’s not always easy to find money to enter the major league, so this way of trading is an opportunity to take a loan without leaving the market. Colleague traders understand the reason you have for the loan, so there is no need to negotiate with third parties in order to convince them that the deal will be profitable.
But there are some disadvantages to this method. First and foremost, margin trading can be extreme in both the reward and the risks involved. In case your forecast doesn’t come to life, you lose the whole deposit, which may be a huge blow. The deposit itself can be an issue as well: sometimes, a substantial amount is needed to start a margin trading deal in the first place. In addition, sometimes you need to spread the actives among different accounts in order to complete the deal demands. Overall, margin trading is an advanced trading strategy, and many experts don’t recommend it for beginners as it can cause significant losses.
Margin Trading on Crypto Exchanges
Multiple cryptocurrency exchanges on the market provide the opportunity of trading. Some of them offer margin trading services in which traders can act as brokers. The algorithm is the same as described before: one trader acting as a broker can lend a fellow trader the funds necessary to implement their trading scheme.
Binance Margin Trading
Binance is a Chinese cryptocurrency exchange currently based on Malta. It is one of the largest exchanges with a daily trading volume of $1.4 billion. As of mid-2018, the platform had 8 million registered users. Binance supports over 500 trading pairs, including all major crypto and fiat currencies, as well as their internal token, BNB.
Binance features quick and easy margin trading services. Any user with a KYC-passed account has a separate built-in margin account. A trader just needs to enroll funds on the margin trading wallet and request a loan for the trade in mind. The feature automatically calculates the risk level, sends the margin calls, and gives advice on how to act in a given position. The wallet also supports the additional supply enrolling on the margin account in order to avoid problems with margin calls. In addition, the system can automatically force the position to close and liquidate the trading asset. The standard leverage is 1:3.
Kraken Margin Trading
Kraken is a US-based cryptocurrency exchange. Founded way back in 2011, it is now a holding that includes Coinsetter, Cavitrex, CleverCoin, Glidera, CryptoWatch, and BitTrade platforms. The main Kraken platform host over $150 million worth of trades daily. There are over 120 trading pairs supported by the platform: multiple major and minor crypto-assets can be bought and sold for fiat currencies such as USD, EUR, JPY, and CAD.
Furthermore, Kraken features margin trading services. It offers a standard 1:5 leverage rate with a $500 thousand limit for loans. The margin service also runs its own API in order to support built-in margin trading features for partners. Moreover, the loan fees offered by Kraken are quite low — for example, it charges only 0,02% for a 4-hour loan. The feature is presented with a user-friendly interface that allows flexible trading and updating the statuses every hour. The exchange offers the option of margin trading to all users but controls the risks very thoroughly.
Robinhood Margin Trading
Robinhood is a traditional stock exchange service based in the USA. The cryptocurrency exchange section was launched in 2019. At that point, within the first five days of the section’s launch, Robinhood gathered 1 million users on the waitlist. At the time of writing the article in January 2020, the exchange supports 17 major cryptocurrencies, including BTC, ETH, LTC, DOGE, XRP, ETC, XLM, and many more.
At the beginning of its existence, Robinhood used to feature margin trading as any traditional exchange but has since excluded margin trading from the list of services.
Poloniex Margin Trading
Poloniex is a US-based cryptocurrency exchange platform launched in 2013. Later, Poloniex was purchased and assimilated by Circle Internet Financial Ltd. At the time of writing, the service operates trade deals with over 100 crypto assets, including all the major ones. The current daily trading volume of the exchange exceeds $90 million.
Poloniex allows margin trading for its users and offers flexible conditions for this type of deals. A user can manually set the amount, stop-limit, selling point, duration, and many other parameters. Poloniex has a clear emphasis on professional use, so the interface is not too user-friendly. However, an experienced trader would appreciate the functions it provides. Along with that, the interface is implemented in a way that provides current information about the deal and updates it regularly. It is also important to mention that Poloniex charges 15% of interest earned through margin trading deals.
Coinbase Margin Trading
Coinbase is another cryptocurrency exchange platform with the headquarters in San-Francisco, California. It is the largest and the leading exchange in America. In fact, Coinbase is one of the key exchanges in the world of crypto. It supports 50 top cryptocurrencies paired with the most popular fiat currencies, including USD, EUR, and RUB. As of January 2020, Coinbase runs transactions worth over $260 million per day. The platform is focused on amateur trading and offers quick services along with a user-friendly interface. The user base counts over 30 million registered accounts so far.
Coinbase features margin trading for Bitcoin, Ethereum, and Litecoin trades. The platform offers 3-to-1 leverage in addition to flexible position conditions. Certain limitations are also present, so it may be challenging for an inexperienced user to start margin trading. For instance, there is a minimum requirement of $5 million-worth of previous deals for individuals, or having a net worth over $1 million for enterprises. It is part of the risk control policy. However, Coinbase’s VP of Business, Data & International at Coinbase Emilie Choi, stated that the company is developing an update of the margin trading policy.
Margin trading is one of the valuable tools in the traders’ arsenal. It is an option that can help you scale the earnings to a whole new level. Slowly but surely, it is becoming popular not only on traditional stock exchanges but also on the cryptocurrency market. The conditions offered by popular exchanges can be quite profitable for both beginners and experienced traders.
However, it is crucial to remember that any trading activity bears significant risks. Picking a wrong position may lead to huge losses, so it is always essential to conduct thorough research before engaging in a margin trading scheme. Trading with margin can cause even more significant damage than conventional trading, so it should probably not be the tool of choice for beginners.