Bitcoin has become a respected and sought-after asset class that is prized by some investors for its profit potential. There are many ways to generate decent returns with Bitcoin trading. One of these involves what it known as margin trading. While margin trading cryptocurrency carries some significant risks, it may be a useful too for the investor that has limited capital to work with.
What is Margin Trading for Cryptocurrency?
Let’s begin with a simple look at what margin trading is. You should know that this method of trading is not exclusive to cryptocurrencies. Margin trading has been used by investors for many years to trade stocks, funds, and the FOREX markets. It is only recently that some cryptocurrency exchanges have started to allow trading on margin for their clients.
The simplest way to explain margin trading cryptocurrency is to state that you are trading with borrowed funds. The cryptocurrency exchange essentially loans you money to trade for a fee. The amount the exchange is willing to loan is based on the equity you have in your trading account. You could have $1,000 to trade. The exchange then loans you another $1,000 so that you are able to leverage more units of cryptocurrency.
The word loan here could be confusing to some people. This type of loan is not one you can withdraw and use for other purposes. It is only a loan that is secured by the capital in your trading account, and it can only be used to leverage units of Bitcoin or other cryptocurrencies.
Leveraging more units of crypto when you trade means that you can make a bigger profit when the market moves in your favor. It also means that you can lose money more quickly when the market takes a negative turn.
How Does Margin Trading Cryptocurrency Work?
The newcomer to trading cryptocurrency may still find it hard to grasp how margin trading works. They often confuse margin with leverage and vice versa. For this reason it is recommended that the newcomer to trading learn as much as they can before making a choice to trade this way.
Leverage is a relatively simple concept to understand. The amount of leverage that you can obtain will vary from exchange to exchange. The amount of leverage that you are given will be expressed as a ratio. 2:1 leverage would double your buying power, while 5:1 leverage would increase it by five times. So, if you had an account with $1,000 and 2:1 leverage you could control $2,000 worth of cryptocurrency.
When the market moves in your favor, the returns that you achieve are increased by your leverage amount because you are trading more units of currency. When the market moves against you, your funds will decrease. The exchange will not let you fall beyond the original equity that you have in your account. But when the market dips the money you lose is being deducted from the money in your account, not the margin loan that you are given.
Ways to Trade Cryptocurrency on Margin
When you trade cryptocurrency on margin you have an option to go long or to go short. To go long means that you are buying Bitcoin or another token in the hopes that the value of the token will increase. When it increases you make money. To go short is to sell a token in the expectation that the price will fall. When the value of the token drops you will achieve a return.
The principle behind margin trading cryptocurrency is that you are engaging in speculation. Speculation about whether the market will rise or fall is what drives the value of tokens. Speculation can be a risky proposition, and it should not be attempted by inexperienced traders.
Why Trade Cryptocurrencies on Margin?
Why would an investor want to trade cryptocurrency on margin? The answer is that margin trading carries the potential of bigger profits because you are working with a larger sum of investing capital. This can benefit the investor with huge gains when they are correct in assessing market movements.
Another reason that some investors choose to margin trade is that they do not have the capital to make large trades. With a margin trading account they can access more capital to trade and make larger returns. This offers them some measure of protection.
Are There Risks Involved In Margin Trading Cryptocurrency?
The answer to this question is a resounding yes. All types of margin trading carries a high risk of loss and should only be done by those with trading experience.
When you trade on margin the cryptocurrency exchange is going to require you to maintain a minimum amount of equity in your trading account. This might be 30% of an open position. While the exchange will not allow you to “go into debt” by trading on margin, your account equity can be drained rapidly when you make a losing trade.
By the same token, your account equity can increase more rapidly when you trade on margin. You should also remember that the crypto exchange is charging you interest on the money that you borrow to trade. Nothing is being given for free to the investor.
Where You Can Margin Trade Cryptocurrencies
The simple buying and selling of Bitcoin on a cryptocurrency exchange is easily managed in most cases. Exchanges don’t have to jump through too many regulatory hoops to provide this basic service. When it comes to margin trading things are different. A cryptocurrency exchange will generally be required to comply with financial regulations in the country of origin.
Let’s take the United States for an example. Margin trading falls under the regulatory control of the SEC. Therefore, many cryptocurrency exchanges are not permitting US citizens to margin trade cryptocurrency at this time. Kraken is the only major exchange that accepts US citizens for margin trading cryptocurrency, although it is sure that more will ultimately follow suit.
Before You Trade Cryptocurrencies On Margin
It is strongly recommended that you adhere to the following guidelines before you start trading cryptocurrency on margin.
- Improve your investing knowledge
- Always use stop-losses to minimize risks
- Limit the size of your open positions
A great many cryptocurrency margin traders make the huge mistake of using up too much of their margin. Do not do this. Never max out your margin on a single position.