Beginner’s Guide to Cryptocurrencies for Margin Trading

In 1940, the odds of children outperforming their parents in terms of income was 41%. In 1980, that dropped to 8%, according to Opportunity Insights. Given the current inflation trajectory followed by large-scale suspension of economic activity throughout 2020, it seems likely that social mobility will continue to decline compared to previous generations.

One way to combat this trend is by investing in deflationary assets – such as some cryptocurrencies. Unsurprisingly, younger generations, led by millennials, are at the forefront of crypto adoption.

There are many ways one can invest in such digital assets. The most passive way is to simply buy an asset, hold it and hope to sell it when its value doubles, quadruples or more. This form of investment, which is largely based on timing, has minted many crypto-millionaires. In May 2021, there were approximately 100,000 BTC addresses with over $1 million worth of Bitcoin.

Seeing such a rapid rise in the wealth of so many, it’s no wonder why some retail traders now view the crypto market as a get-rich-quick scheme. Within this mindset, one of the more active investment methods to use is margin trading, which traces its roots all the way back to the late 1800s as a way to bankroll railroads. As we move forward over 120 years, let’s take a look at how margin trading works in the crypto space.

What is Margin Trading?

Margin trading uses your market position to reap greater rewards with a small initial investment. This is possible by adding collateral called margin – the funds you borrow from a third party (broker or exchange) – to your trade. However, in the same way that your leverage can bring you X times profits, it can also lead to devastating losses if the asset’s price defies your expectations.

In practice, if you trade $50 of BTC margin for a 5X leverage, you will borrow $200 to buy $250 of Bitcoin (BTC). Therefore, your effective trade to enter the market with will be $250 instead of $50. In turn, no matter how the trade turns out, you will have to return $200 + the platform’s fees.

If a crypto’s price movement goes wrong – down instead of up since you entered your position – the crypto exchange will “margin call” your trade when the price reaches a level when you start losing borrowed funds. To avoid getting margin calls and turning your trade into a loss, you need to keep adding funds above that level.

When you bet that the crypto’s price will fall, you enter a short position. Accordingly, when you bet that the crypto’s price will rise, you are entering a long position. In the crypto space, margin trading is particularly risky because crypto assets are inherently volatile. After all, they all have relatively low market caps (compared to the traditional stocks, that is) which makes it more likely that crypto whales can move prices to their advantage. For example, Bank of America recently estimated that it would take $93 million to move the price of BTC by 1%.

According to Tim Fries, co-founder of financial education platform The Tokenist, margin calls carry significant risks. When a margin call cannot be met, many traditional stockbrokers have the right to close other open positions held by the investor to meet the minimum amount in the leveraged position. Fries explains:

“Margin calls can end up costing you a large amount in short-term capital gains taxes, as well as unrealized gains from investments that show signs of recovery or further growth.”

For this reason, it is wise to start your margin trading small – under $100 – and increase in fractions. Likewise, you must have a clear plan for when to exit the market and take the profit. Many traders get too greedy and want to test the volatility beyond the breakeven point. More often than not, there is a price reversal and the investor has to cut their losses instead.

Margin Trading in practice

Although exchanges have different interfaces and styles, you’ll notice that they all share the same key elements:

Price charts with tools – technical indicators, from Japanese candlestick to MACD, RSI, and many others. They help you understand the probability of the asset’s price movement. Based on that, you decide whether you want to get involved in a short or long position. Order book – just like in the stock market, order books record buy and sell orders and their ask and bid prices. This is very useful because an order book can visualize buy or sell walls. If there is a higher buy order volume, the price will tend to rise and vice versa.

Then you have the range of possible leverage – from 2X to 300X – although most exchanges have limited it to 200X or lower. Here’s how margin trading works in practice. Let’s say you commit to a $500 position, equivalent to 500 USDT. With a leverage of 10X, you would effectively enter the market at $5000.

Then you have two options – manually track how your trade is performing or automate it. In the crypto space, automation of margin trading is accomplished with two tools:

TP – Take Profit order – allows you to adjust the profit range, either by a percentage or raw value, resulting in you automatically exiting the market when the pre-defined profit is reached.SL – Stop Loss order – lets you then to adjust the loss range you are comfortable with to automatically exit the market at a loss.

As previously mentioned, if your account balance falls below the Maintenance Margin Requirement (MMR), your margin will be called. To prevent this, your account will either need to be topped up to account for 10X loss (as per our example above) or additional funds will need to be added during the margin trade.

If you follow this logic, you will immediately see how devastating margin trading can be. You enter a certain bet – short or long – and the price goes against that bet. Then you hope it’s temporary so you add more funds to the trade to avoid getting margin calls. However, the price may continue to go the other way from your market entry position, inflating losses even further.

As you can see, the risk falls entirely on your shoulders. On the other hand, the whim of the crypto market can also give you huge profits. To reduce the risks involved, do not invest more funds than you are willing to lose. Just as importantly, learn to read technical analysis indicators so that you can properly employ them to maximum effect.

With this in mind, it is a best practice to trade with demo accounts and virtual funds first. This allows you to put your strategy into practice without any risk whatsoever.

Digital assets are increasingly being integrated into many aspects of the world, from automating payments for businesses to, you guessed it – margin trading. Here are some of the most popular cryptocurrency exchanges that offer margin trading:

StormGain – zero commission for spreads, demo account and up to 300X leverage.FTX – tiered fee structure, demo account and up to 20X leverage.Kraken – up to 5X leverage, and one of the lowest fees for US residents.BitMEX – up to 100X leverage, automatic exemption if there is insufficient liquidity to execute orders.

Due to the high-risk nature of margin trading, both Coinbase and Binance have recently limited or excluded this feature for retail investors. This – in itself – should warn you not to take margin trading lightly.