Margin trading is essentially a form of trading in which at least a part of the consideration for the transaction is borrowed. For e.g. If the consideration for a transaction is $100 and you have only $70 in your account, your crypto exchange or broker can provide you with the remaining $30 in order to carry out that transaction. In this form of transaction, this margin of $30 that is provided to you by your exchange is essentially a loan that needs to be repaid with the interest levied by the exchange when the margin call is made.
Anyone looking for additional leverage in their investment could be right for Margin Trading. Leverage is when you borrow capital as a funding source while investing to expand your assets, to increase the potential return of an investment. It is particularly famous in the international Forex market which has a low-volatile market but is also used in Stock, Cryptocurrency, and Commodity markets.
How does Margin Trading Work?
Suppose you want to buy 10 pens worth $2 but you only have $10. With the money you have, you can only buy 5 pens; so you borrow $10 from your broker to be able to buy 10 pens.
Now if the prices rise, you will have double the profit. Say the price of pens rises to $5 per pen, then your investment becomes $50 where if you pay back $10 you still have $40 left.
In case, the market prices stay neutral than you still incur a loss as there is an interest on the amount you borrowed after 24 hours.
But if the price of the pens falls to $1 per pen than your loss doubles. You still have your loan to be returned and you also face a loss due to market prices dropping.
It is extremely important to maintain a balance of at least 50% between your debt and the part you own (equity). If it falls below the limit, you have to restore it by depositing more stock or more cash into the brokers’ account. This number varies in different markets.
In margin trading, you don’t have a set repayment schedule. As long as your required level of equity is maintained in your account you can pay it back as and when you want.
Long and Short Positions
Margin trading has a Long and Short Position. It stands for the period of time in the trade.
Long Position is when the trader thinks the price will go up in the future, so the trader buys up additional cryptocurrency to sell when the prices go up such that they make a price.
Short position is when the trader thinks the price will drop in the future and dumps his holding in order to buy the same at a cheaper price and thus make profits.
Types of Orders
Multiple Target Orders – With multiple target orders, one can set different targets for various tranches. For eg. if you have 10BTC, you can set the order to sell 5BTC at $5000 and the remaining 5 at $7000
Limit Margin Order – A limit order is basically an order wherein you can set a minimum or maximum price to buy sell or bull a cryptocurrency. A limit margin order is thus an order wherein you execute a limit order with leverage taken from your exchange. In DCXMargin, this leverage can be toggled between 1x to 4x.
Market Margin Order – This is a simple market order which is executed with some amount of leverage.
The main advantage of margin trading is the increased buying power which comes from the additional capital that can be used if the balance in your wallet is less than the total size of the transaction. This gives the buyer additional power to trade in cryptocurrency. Trading on the basis margins is especially advantageous in a situation when you want to take a long position and need some extra money to buy additional cryptocurrency.
Margin Trading is also advantageous while undertaking risk management activities such as hedging and is also used for practices such as speculative trading or if you do not want to spend all the balance in your wallet.
Though there are many advantages to margin trading, there are certain disadvantages as well.
The biggest disadvantage is the interest one has to pay on the borrowed funds, especially if you have made are making losses. As explained in this article, the one principle of margin trading is that regardless of whether you make a profit or a loss, you always have to return the funds borrowed along with the interest levied on it. What this means is that, even if you have made a loss, you have to return the collateral you have borrowed along with the interest upon it, thus adding to your loss.
Another major disadvantage of margin trading is that because the margin on the trade has to be returned, one would have to sell cryptocurrency which is bought through such transaction in a limited amount of time and thus cannot be held onto for a long period of time. Additionally, if you are not able to repay the margin when the margin call is made, the exchange can also square off your positions to regain the margin, and thus you may also risk losing your cryptocurrencies.
The most obvious advantage of Margin trading is that the profits are larger but just like the profits the loss can be larger than usual too. Margin trading is has a high-risk factor especially in Cryptocurrency markets which are high-volatility markets. One must be extremely careful and understand the markets while trading on a margin. Even a high understanding of the markets isn’t enough to not incur losses because of which it’s definitely not meant for beginners
CoinDCX offers its own Margin trading Product, Margin. This can be used as a platform to do margin trading on cryptocurrencies.