Cryptocurrency margin trading is a type of trading that aims to make a profit on the exchange.
Margin trading differs from ordinary trading in that the trader uses his assets and borrowed funds, which he borrows from the exchange against the security of his assets.
With the help of borrowed funds, he can buy and sell several times more cryptocurrency than he could do using only his capital. Therefore, the benefit from successful operations also increases proportionally several times.
The name “margin trading” comes from the word “margin”, which means collateral.
Margin is the trader’s funds, which he provides as collateral when taking out a loan.
How margin trading works
Let’s say an investor has $ 100 and is confident that a particular cryptocurrency, for example, let’s call it COIN, will grow.
He wants to buy COIN now to sell it at a higher price and make a profit in the difference between prices.
But for $ 100, he can only buy 1 COIN. This is too little to generate significant profits.
Then he goes to a cryptocurrency exchange with the possibility of margin trading and borrows money there. He borrows them not from the exchange but from another crypto investor who provides loans to everyone at a certain interest.
The exchange determines the maximum amount that a trader in need of money can borrow from a lender. This amount is designated by the concept of “leverage” and is indicated as a coefficient.
Leverage 1:1 indicates that the trader can borrow from the lender as much as he has in his account. In our example, this is $ 100. Leverage 1:2 allows you to borrow twice the amount on your account — in our case, $ 200. Leverage 1:3 will enable a trader with $ 100 to borrow $ 300, and so on.
For the entire borrowed amount plus his funds, the trader can buy the mentioned cryptocurrency. If for $ 100, he could buy 1 COIN, then for $ 100 + borrowed $ 300 (with a 1:3 leverage), he can buy 4 COIN.
If the COIN price rises, for example, by 10% and is, therefore, $ 110, the trader will sell the purchased 4 coins for $ 440 and make a profit of $ 10 x 4 = $ 40. From the $ 40 earned, we deduct the exchange commission for the transaction (0.1–0.2%), the commission for taking a loan (also about 0.2%), and interest on the loan.
$ 100 — his initial funds — also remain in his account, and he returns $ 300 to the creditor. Net profit, including all commission fees, will be about $ 35
If the trader did not use borrowed funds and only traded his $ 100, he would have made a $ 10 minus the exchange commission.
When the trader’s expectations of who took out a loan are justified, the situation unfolds to everyone’s benefit. Upon closing a successful deal, the trader himself remains with a profit and returns the funds with interest to the lender.
But the trader’s expectations may not be met.
For example, our virtual COIN, from the above example, may not grow by 10%, but rather fall by 10%.
It turns out that the trader bought 4 COIN for $ 400, but can only sell for $ 360, that is, with a loss of $ 40.
The lender should not suffer from the trader’s forecast not coming true.
As soon as the value of the trader’s assets (both borrowed and own) reaches the size of the loan with interest, that is, the amount that the trader must return to the lender, the exchange automatically closes all the trader’s positions and returns his funds to the lender.
In this case, the amount returned to the lender fully includes the margin — the trader’s funds that he initially had and which he provided as collateral. Thus, he loses, in addition to the borrowed assets, also his own.
This situation is denoted by the term “margin call” message about the approach of the limit. It warns the trader that the limit is approaching. Upon reaching the limit, the fund from the account will be deducted in favor of the lender. The so-called “liquidation price” of an open position comes.
To prevent this from happening, the trader can replenish his account, thereby avoiding the forced closure of the position and losing all funds. However, such a strategy can lead to even more losses if the price of the coin does not turn in the trader’s right direction.
Also, the difference between margin trading and ordinary trading is that when buying a cryptocurrency without leverage, a trader becomes its owner. He can withdraw it from the account, sell it, and transfer it to another person, and so on. When buying with leverage, he can withdraw neither it nor the margin until the trade is closed.
As seen from the above, margin trading in cryptocurrency allows you to get much more income than when a trader uses only his funds.
But, at the same time, the risks increase significantly.
As you can see, without some training, a person may face difficulties in margin trading with a high degree of probability.
Praem Capital successfully applies proprietary technologies and algorithms that allow you to get the maximum income from margin trading. Also, the partner of the Hedge Fund from Luxembourg provides insurance against possible drawdowns in margin trading. All this gives the best results and guarantees investors a constant income of 8 to 18% per month.