What is margin trading
What is margin trading
Updated 03.12.2021

Margin trading is understood as a separate type of asset trading operation at the expense of funds provided by a third party. Margin trading accounts open traders an opportunity to use large amounts of funds that they can use to implement their plans. The main goal of margin trading is to increase efficiency, which allows traders to improve the profitability of executed deals. It positively affects the returns of the trading operations: that is why margin trading is in great demand in markets with low risks. It is worth saying that margin trading has also found use in other markets where it shows good results.

If you need to get extra funds and work in one of the standard markets, you need to appeal to an investment broker. The situation differs when you trade digital currencies since, in most cases, other traders initiate to help and provide extra money because they receive income in the form of interest on margin funds from this method. Currently, the function is only gaining momentum. For this reason, only a small part of digital currency exchanges provide users with a chance to involve extra funds.

How margin trading works

The starting point to launch trading on margin is when a trader fixes a percent from the overall cost of an order he owns. This investment is considered a margin; its distinctive feature is the presence of a close link to the concept of leverage. I.e. the availability of margin trading accounts gives traders a chance to make deals by having taken the necessary funds from a third party, but this method is fraught with risks and losses; that is why it requires a smart approach and planning.

The practice shows that the existing trading platforms and organizations offer their own set of rules and leverage. As an example, we can consider a standard situation in a stock market, where a widespread option is the ratio of 2:1, and a slightly different situation is when it comes to futures contracts: in this case, the identical indicator is 15:1. Broker operations usually have a ratio of 50:1, and we should also highlight special precedents when leverage may reach 100:1 or 200:1. The leverage in the market of digital currencies may vary from 2:1 to 100:1. Experts in the field of trading take a designation ‘x’, using which it is possible to describe the profitability growth in a specific type of deal.

Margin trading is a universal way to open positions regardless of their profitability and price. A long position brings to the fore a suggestion that the asset price will be increasing; a short position characterizes the opposite situation. As long as a margin position is available, the assets of a trader serve as a basis to secure the funds given to him. And that is a significant factor for traders. The thing is that many broker companies may sell these assets in some cases: for example, when the market movement doesn’t correspond to the company’s course.

As an example, we can look at the situation when a trader forms a long position based on the funds given to him by an exchange or a broker, but its price starts reducing under the influence of various factors. As a result, the funds are not added to the balance, and the trader must invest more funds to stabilize the situation, which will allow complying with the margin requirements. If the trader doesn’t do it, his funds are sold by an exchange to compensate for the losses. In most cases, such a scenario is typical when the cost of the whole volume of assets is lower than the indicators formulated by the exchange or broker.

Advantages and disadvantages

The main advantage of margin trading is that using it, one can significantly increase profitability due to the growth of a relative cost of available assets. Also, margin trading works well for risk diversification; it is due to the fact traders get access to opening several positions, with a chance to deposit small amounts of money. In the end, the availability of margin allows traders to open new positions without significant time and finance costs.

It is important to note that margin trading has one disadvantage: both losses and profits will increase exponentially. Margin trading is characterized by high risks. Depending on the amount of funds provided to make a deal, even a little reduction of price in the market may result in huge losses for traders. In this regard, before using this method, it is recommended to develop the right strategy of risk management that should be based on the combination of tools designed to reduce risks. Only such an approach will allow getting high profit without the risk of losing all the assets at a time.

Margin trading in the market of digital currencies

The described type of trading is always associated with high risks; in the market of digital currencies, these risks are even higher. Considering the fact that a high level of volatility is an undivided part of digital currencies, traders taking a margin as a basis should thoroughly analyze their actions and take into account all the factors. For that reason, margin trading is not recommended for use to novices in trading as one wrong action may lead to the loss of all assets.

This method is more relevant for those having prior experience and who can correctly draw up strategies appropriate to the current tendencies in the market, targeting the long-term perspective.

Integrated study of charts, determining of trends and points of entry and exit do not exclude the possibility of potential risks specific to margin trading. But such an approach allows predicting the events better, which positively affects the increase of efficiency of trading operation implementation. For this reason, before you implement this strategy for trading digital currency, you need to form skills of technical analysis and gain practical experience.

Margin funding

There is an alternative method for those investors who don’t tend to risk and want to study the specifics of margin trading independently. The method allows getting profit by using the funds provided by an exchange or broker. It is not difficult to distinguish many trading platforms and digital currency exchanges that offer so-called margin funding. Within its framework, traders get access to providing their funds on maintaining deals that are made by other traders.

In most cases, this process is executed in accordance with specific conditions and grants dynamic interest rates. If a trader agrees to voiced conditions, the provider may clear a debt with a tentatively set interest.