Everything You Should Know About Margin Trading

Margin trading means that you need to invest the margin (a certain percentage of the overall investment costs), and the rest of the funds are borrowed from a brokerage company or from a crypto exchange.

When talking about trading, users have two paths to pave: spot trading and margin trading. Many trading platforms combine both paths empowering their clients to either choose one of the ways or prefer a hybrid model.

Why is the popularity of margin trading rising, and what are the core advantages and risks related to such type of investment?

What is Margin Trading and How It Works?

While opening a margin position traders do not need to invest the full price of the chosen asset. A portion of an underlying asset’s value is entirely enough to open a position. Your broker or crypto exchange loans the rest of the required funds to you.

Let’s dive deeper into margin trading to understand how it works in some examples.

A trader is going to purchase 0.5 Bitcoin at a price of $60,000 per coin. In the case of spot trading a user needs to spend $30,000; meanwhile, margin trading cuts his expenses significantly. For instance, the leverage 1:10 (10x) requires an investor to spend just $3,000 to add 0.5 BTC to his portfolio. The multiplier 1:100 (100x) makes it possible to purchase 0.5 BTC with $300.

The higher multiplier investors select, the lower investments are required. On the other hand, high leverages imply high risks.

Leverage in Margin Trading

Leverage reflects the ratio between a trader’s own and borrowed funds. The higher leverage investors set, the less money they invest in a position.

For instance, the leverage 1:10 means that a trader uses 10% of his own funds and 90% of costs borrowed from a brokerage company or a crypto exchange.

What are the possible leverages offered by trading platforms? Multipliers depend much on the following criteria:

• brokerage company/crypto exchange;
• jurisdiction;
• asset class.

Every brokerage company and crypto exchange defines its maximum on its own. Some offshore brokers unlock multipliers up to 1:2000 (2000x) which means a trader needs to invest just 0.05% of the overall position.

Brokerage businesses and exchanges meet the requirements set by financial regulations. In the EU the maximum possible leverage is 1:30 (30x). Brokers and crypto exchanges regulated by CySEC and other EU-based regulators cannot offer multipliers that exceed such limits.

Furthermore, platforms may set independent limits for every asset class. Users may trade metals with a multiplier up to 1:100 but for stocks, the maximum leverage is 1:20.

Newcomer traders frequently use high multipliers; meanwhile, they do not take into account the growing risks. Every percent of your profit or loss is multiplied at the chosen leverage:

• A trader opened a position with the leverage 1:10. The underlying asset’s price increased by 2.5% which means his profit is 25%.
• A trader opened a position with the leverage 1:20. The underlying asset’s price dropped down by 3%. A trader lost 60% of his initial investment.

Isolated Vs Cross Margin. Which Margin Type is the Best One to Choose?

When a trader opens a margin position, two possible options are available – he may select either isolated margin or cross margin. What are the differences between those options and which margin type is the best decision?

Isolated margin enables a trader to define the exact amount of money used as a margin. The platform cannot charge more funds.

Cross margin means that your margin position may take funds from your deposit. In such a case the whole deposit is understood as margin.

Let’s compare those types in examples.

• A trader opens a margin position and invests $100 selecting the isolated margin type. When the invested $100 doesn’t cover the losses, the platform closes the position forcedly, and a trader loses the invested funds.
• A trader opens a margin position and invests $100 but selects cross margin. The overall deposit is $500 which means that the platform will access other funds to cover losses in case an asset’s price will go in the opposite direction.

What is the best solution for a trader? Both isolated and cross margin types have pros and cons. The isolated type enables traders to get the fullest control over their positions and add margin when they want. As for the cross margin type, it minimizes risks; meanwhile, this type is not the best decision when a trader opens many positions. The same concerns high leverages – when a trader uses a high multiplier (1:20 and higher), cross margin may rapidly eat up his deposit.

Long and Short Positions in Margin Trading

On a spot market, investors may just purchase a certain amount of an asset, and then sell it. As for margin positions, traders may open either long (purchase) or short (sell) positions.

• Long position means that a trader has purchased a certain asset and expects its price to rise as much as possible.
• Short position means a trader has sold the underlying asset; therefore, he needs its price to drop down.

Fees and Commissions Related to Margin Trading

When you borrow funds from a brokerage platform or a crypto exchange, you need to pay some extra fees that depend on a certain asset and a trading platform.

For instance, Kraken, the crypto exchange charges 0.02% for opening a position and an extra 0.02% per 4 hours for holding a position. Bybit charges 0.02% on an hourly basis. Brokerage companies may set fixed commissions related to margin trading. Take into account that fees are multiplied depending on the leverage you have selected.

When talking about futures, traders do not pay fees for using borrowed funds; meanwhile, they face funding.

The funding rates reflect the difference between the futures and spot prices. Funding fees serve as a mechanism that aligns both prices to prevent gaps. Traders holding futures positions either pay funding commissions or receive them on their accounts – funding can be positive and negative. Such commissions are charged three times per day. As for funding payments, those are also multiplied by the chosen leverage.

Advantages and Risks of Margin Trading

Here is the list of top advantages related to margin trading:

• The possibility to apply the leverage. Traders get higher amounts that increase possible profits. Depending on a brokerage platform or a crypto exchange, users may access capitals that exceed their investments by 2-2000 times.
• The possibility to earn on both markets. Spot traders get profits when the market grows. Margin trading enables users to earn on both bullish and bearish markets.
• The variety of trading strategies. Margin trading unlocks a set of diverse strategies that imply different assets: Forex, stocks, indices, etc.
• Low barriers to entry. Most markets require large amounts of money to enter but leverages help traders and investors penetrate into the niche with as low investments as possible.

The advantages of margin trading are evident. What about the risks traders face when using multipliers?

• Higher losses. Leverages augment both potential profits and possible losses. The higher leverage a trader selects, the easier he can lose money.
• Financial risks. Margin trading means that the smallest market volatility may liquidate your position; which is why traders need to make a deeper analysis and take all the criteria into account while predicting further price movements.
• Liquidation risks. On the spot market, you cannot lose all your money when the market goes in the opposite direction. Margin trading may liquidate your position completely.

What are the margin call and liquidation price as the core risks of margin trading?

Margin Call and Liquidation Price

Margin trading means that a trader uses funds borrowed from a broker or a crypto exchange. Trading platforms do not do charity work. They borrow funds to get higher commissions from a trader’s position. At the same time, platforms do not allow clients to lose borrowed funds.

The liquidation price is an asset’s price when a trader’s own funds are over. When an asset’s price reaches the liquidation price, a platform closes your position forcedly. Let’s explain this situation in the following examples:

• A trader opens a margin position and purchases TSLA stocks (long). The price of 1 stock is $209. With the leverage 1:20, a trader has purchased 4 TSLA stocks investing just $41.8 instead of $836. Meanwhile, a 5% price drop means that a trader will lose 100% of his investments (isolated margin). A trading platform sets the liquidation price at $198.55.
• An investor opens a short margin position using the NASDAQ Composite index. The index price is $17,754 but a trader uses the leverage 1:100. He sells one contract investing just $177.54. At the same time, the liquidation price is $17,931 (1% higher than the initial price).

A margin call is a notification that a trader needs to fuel his position with extra funds; otherwise, a trader’s position will be liquidated.

When a trader has no extra funds or ignores the margin call request, a trading platform liquidates the position taking the borrowed funds back.

Recommendations and Useful Tips on How to Open Margin Trading Positions

Margin trading implies higher risks; this is why traders need to take into account some pieces of advice that prevent them from losing money:

• Trade on brokerage platforms and crypto exchanges that guarantee the highest liquidity for assets you are going to use.
• Rely on profound technical analysis when making your predictions. Avoid hasty decisions.
• Start with minimum leverages. Experienced traders do not usually use multipliers higher than 1:20. As for beginners, leverages 1:3 – 1:5 are entirely enough.
• Test your strategies on a demo account. Such a mode is perfect for beginners who just make their first steps in margin trading. Demo accounts help users understand how the mechanisms work and avoid losses.

Bottom Line

Margin trading enlarges the opportunities available for traders. They access much larger capitals and may get profits on both bullish and bearish markets. On the other hand, margin trading implies higher risks – users may easily lose their deposits. This trading mode is definitely useful but traders need to make profound analysis and follow the risk management strategies strictly.