What you need to know about margin trading

Published 07 September 2020

Every trader knows that the more assets are put on stake, the larger potential earnings are. Does it mean that you cannot start growing your income until you have enough funds to make a huge deposit? Not at all. The margin trading tool enables everybody to conclude large-scale deals without having significant sums on their balance.

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What is margin trading?

Margin trading is the use of borrowed funds to trade assets, which allows placing orders for sums exceeding the initial deposit several times. The latter is called “margin” and its size depends on the leverage.

Leverage means the ratio of the margin to the borrowed funds used to open a position. In other words, it shows the number of times the credit exceeds your assets. For example, if you have 3 BTC, the 5x leverage will let you trade 15 BTC. The leverage size differs and can range from, say, 2:1 in the stock market to 100:1 in the cryptocurrency one.

Margin trading in cryptocurrency markets

Trading crypto with a margin takes place on a cryptocurrency exchange that lends funds to its users. It differs from regular trading, as cryptocurrencies have a higher volatility rate than fiats. This means higher risks and higher profits depending on whether you have correctly identified the price trend and chosen the right position.

Margin trading can be used for either long or short positions. The long one is opened when the currency rate is expected to grow in the long run, and the short one is activated when the asset price is likely to drop soon. The trader’s funds serve as collateral for credit funds while the position is open. That should be kept in mind because in case the position becomes adverse, the lender can liquidate it to cover their losses.

The difference between a spot exchange and a margin trade

A spot exchange is buying/selling assets at the current market price. Essentially, it means exchanging the assets you already own in one currency for the same amount in a different currency. For instance, you can exchange 100 USD for BTC on the USD/BTC trading pair. As soon as you have completed the swap, you can make another exchange or withdraw the funds from your balance.

In contrast to the spot exchange, margin trading does not require that you have the sum of the assets equal to the size of the position you want to open. You will be provided with leverage and will have to deposit a certain percent of the funds traded. The collateral currency does not have to be among the currencies from the margin pair you are going to trade. For example, you can deposit EUR and trade the ETH/USD pair.

Another point worth noting is that with margin trading, the assets necessary to place an order are not credited to your account but are indicated as a “position”. The profit or loss will be reflected in your balance when the position is closed. If you trade with leverage on WhiteBIT, once the position size is reduced, the profit/loss will be shown on the balance.

Advantages of trading with leverage

Margin trading has made it possible to get high profits with a small deposit. Leverage allows multiplying funds to place larger orders, which provides an opportunity to get many times bigger income in comparison with spot trading.

Leverage multiplies profit in case of the desired rate move but incurs losses when the price on the acquired currency drops. Thus, the key to success is to determine the future price trend and take the right position. Let’s see an example of how you can earn whatever the price shift.

When you expect the currency rate to rise, you should take a long position. That means you should buy an asset at a low price, wait till it gets higher, and sell the asset to get the profit. Imagine you have got $5000 and want to buy 1 BTC for $10000, using a 2x leverage. After you have acquired a Bitcoin, you should wait till its price reaches $11500 for a unit, sell it, and your profit will amount to $1500 (trading fee not included).

If the price is about to drop, you should open a short position, that is, borrow funds to sell the asset at a high price. When the price falls, you will buy the asset again at a lower price than you have sold it and profit. For instance, with $5000 on hand and a 2x leverage, you can get 1 BTC for $10000 and then sell it. After that, you should wait till the Bitcoin price declines to $8000 per unit to buy it again. Thus, your profit will be $2000 (trading fee not included).

A lower initial deposit not only allows you to trade larger amounts meaning a higher potential profit but also lets you diversify your asset portfolio. Having various currencies hedges risks, and with more funds at your disposal, you can invest in new assets without liquidating other investments.

Margin call and liquidation

A careless approach to trading with a margin may lead to losses instead of profit. A margin call is a notification of a user about the fact that the position is unprofitable and may soon be liquidated. Users are given an opportunity to respond to the current market situation with one of the following options:

  • reducing the position size till it is completely closed;
  • Depositing funds to the margin balance to get the position out of the “margin call state”.

Let’s see how it works (trading fees not included). A user has 2000 USDT on their margin balance and an open Long position for 1 BTC (at the price of 10000 USDT) with a 5x leverage. The initial margin amounts to 20% from 10000 USDT, which is 2000 USDT. If, after the losses, the sum of margin balances expressed in USDT will become less than 65% of the initial margin, you will get a margin call.

When the losses on the position reach a certain point, the position will be automatically liquidated at market price. It involves returning the borrowed funds that were used to open it. For example, a user has 2000 USDT on their balance and an open Long position for 1 BTC (at the price of 10000 USDT) with a 5x leverage.

If, after the losses, the sum of margin balances expressed in USDT will become less than the maintenance margin, your position will be closed/liquidated. The maintenance margin equals 50% of the initial margin.

Bottom line

The margin trading tool can help you multiply profit many times, and it is used for both the rising and decline of an asset price. To succeed in trading with leverage, it is vitally important to identify the future trend and the right time to enter and close the position.

Having mastered margin trading, you will be able to improve your trading income significantly. On WhiteBIT, you can trade the BTC/USDT, ETH/USDT,and ETH/BTC pairs with the maximum leverage of 5x. Make use of the tool to benefit from trading on an exchange and become a pro!

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