Margin trading cryptocurrencies: benefits, risks and how to reduce those risks

Margin trading allows any cryptocurrency trader to borrow funds in order to leverage their bets, and is a very desirable option when odds are in the trader's favor. It multiplies your profits. For instance, using margin or leverage of 2:1 or 2x, you are able to buy $10,000 worth of cryptocurrency by owning just $5,000. Depending on the exchange which is lending, a trader can either pay a certain fee or not pay any fee at all when they borrow the funds to trade on margins.

Shorting your bet means you bet the price will go down after a given time and you lose money if it goes up. Going long means you bet the price goes up and you lose money if it goes up. You basically set a bid on price and then close it at a certain time, manually or when the set price is reached or when the funds in your account run out and the exchange calls your position.

How it works

The simple rules apply when margin trading: if the cryptocurrency you are betting on goes down or stagnates, you will still owe the money and the interest. This is important because the money is usually borrowed at relatively high interest rates. The amount you can leverage also depends on the currency pairs in addition to which crypto exchange or trader is lending you the money.

Because the amount lost after margin trading is based on your total bid size, it is advisable to use risk management when margin trading.

Most crypto exchanges that offer margin trades will require you to keep a minimum level of equity in their account, for instance 30% of the open position. The crypto exchange does a “margin call” when your funds runs out from the account or falls below the “Maintenance Margin Requirement (MMR),” which happens when the price trend is going against your bet and the balance falls below this required minimum. They might also start liquidating your assets to get their money back.

You are able to offset a “margin call” by contributing or adding more money to the order book or account in which you have the margin in order to avoid the liquidation or closing of the position by the exchange. Depositing more money in that order book increases your margin ratio and improves your call price.
When it is margin called, the position is traded on the regular market to close the position and the money is gotten back to pay off the loan -- if the crypto exchange facilitates loaning of actual asset and not a derivative market.

Apart from in a derivative market, in margin trading, a cryptocurrency will loan you funds in order to place larger trades, but the loan is collateralised by the funds in your account and is to be paid back with interest. Margins are used to create leverage, which means a higher buying power that allows you to open larger positions than you would afford with current amount of funds in your account. The two terms are used interchangeably.

Should you do margin trading?

It is advisable to use margin trading only when you are certain of the moves, are an experienced trader and have done good research on margin trading. Margin trading is recommended for hedging trading. Of course losing money in crypto trading can be very stressful even without borrowing funds and therefore the stress can only be added with margin trading.

Otherwise, margin trading can be very helpful when time is right: you earn extra profit you shouldn't have because of your initially limited capital.

Once you are decided on proceeding with cryptocurrency margin trading, you can get well versed with technical indicators used in crypto trading, know how to enter and exit a crypto trade, read all the technical information about how to proceed with margin trading in a given crypto exchange.

Margin trading jargon such as margin ratios and “margin call” should be at your fingertips. Then, besides understanding the technical terms, it is necessary to also check out for some margin trading strategy. What is your strategy in margin trading crypto after knowing how it works, how to use technical indicators in trading, how to enter trades, etc? 

In addition to this, there are many places where you can trade margin cryptos right now. Bitfinex, for instance, offers an initial margin limit of 30 percent where trader can use this to prevent sudden market swings and losing your assets altogether. Bitfinex has a maintenance margin limit of 15 percent where the margin call occurs and the position forcefully closes to avoid your balance going negative.

Peer-to-peer lending systems like Bitfinex allow you to borrow from persons through an exchange that manages that loan to ensure it is returned back to the lender on the platform.

BitMEX offers up to 100x leverage without expiry on trades. With BitMEX, you are able to deposit Bitcoin, get margins and buy and trade bitcoin, Cardano, Bitcoin Cash, Ether, Litecoin and Ripple. You can access the orders, select one you want to trade, set the type of order you want to place, then set your leverage (5x, 10x etc), and then open the position.

Unlike Bitfinex, however, Bitmex is an example of a derivatives market where the asset being traded does not change hands in order for the borrower to take a position. The two parties will take opposing sides of a futures contract. Therefore, this type of a loan allows you to have a fraction of the equity of a contract instead of taking out a loan of the crypto asset.

The maintenance balance in a derivative market like Bitmex is used to protect the exchange from negative balance. The exchange will take on the position at a margin call and close the position, with the maintenance balance also taken to offset the loss of the liquidation engine.

In addition to shorting (where you sell in advance and buy later when prices fall and hence benefit from the falling market), you can use margin trading services to do scalping or swing trading in cryptocurrencies.

Ratios, bet sizes, and risks of margin trading

Although many people enter margin trading because it can amplify profits, it can also end up amplifying your loses and you can even lose the entire balance if the loss exceeds the balance. Because margin trading cryptocurrencies is one of the riskiest bets that you can take, it is necessary to understand the risks that you face, for instance ability to lose your entire initial investment margin trading and the fact that you could lose money with low volume and high volatile altcoins.

First, the likelihood of having the margin called in by the exchange goes higher with the increase in the amount you are betting. For instance, if you go long on a 4:1 margin and the position goes down by about 25%, it is highly likely to be called in. That is obviously because you are risking to lose the lender's money. However the position will be open as long as you like if it goes up.

How to deal with risks in margin trading crypto 

Many people also lose money when the crypto value is going down because they add their position (put money into the order book) in order to keep the position open.

As a tip, you can have the leveraged portion of the trade automatically settled if it is not possible for you to execute the trade in time when the time limits for the margin trade is reached.

It is also advisable to use margin shorting to protect yourself from price drops if buying large amounts of cryptocurrency, instead of using leverage margins to speculate on prices. Using leveraged positions is a lot more risky than hedging. Otherwise, it is advisable to do detailed technical analysis to familiarize yourself with the prices and possible trends.

Talking about risks, many people use margin trading to keep less cryptocurrency on an exchange at a time (and use the amount for leveraged buys) while the rest is in a cold storage. This is far less risky than speculating with leveraged positions although the position can equally be liquidated when the cryptocurrency is on a downward trend. Remember that you can lose money easily when margin trading because short-term price movements can force you to close a position.

Another issue with margin trading is that you will be making short-term capital gains and losses that are subject to short-term capital gains tax. This is unlike those who hold long (can enjoy long-term capital gains rates).

Due to the many risks involved, trading margins is not advisable for newbies in crypto trading.

There are many other ways through which you can manage risks involved in margin trading. For instance, you can set stops and hedge margin positions with another margin position or with spot buying (buying actual crypto).

For instance, apart from the fact that you should stay away from margin trading if you are a newbie in crypto trading, you need to start slowly. A low level of leverage will see you cap any risks to minimum and help you avoid losing all funds in a single transaction. Again, you can use stop-loss and take-profit orders to set clear limits for closing positions. This can help avert huge problems.

Apart from watching the prices themselves, a trader should also watch shorting trends among crypto traders. For instance, when a cryptocurrency is heavily shorted, the crypto may move sharply higher and this can force more short sellers to close out their positions and leading to upward pressure on the cyptocurrency price. This condition is known as a short squeeze. Knowing when it happens can help you take the right move in trading cryptocurrencies using margins. 

David Kariuki

David Kariuki likes to regard himself as a freelance tech journalist who has written and writes widely about a variety of tech issues that affect our society daily, including cryptocurrencies (see cryptomorrow.com and coinpedia.org); climate change (cleanleap.com), OpenSim and virtual reality (see hypergridbusiness.com). He is currently pursuing a MSc in Environmental Management at Open University. He does write here not to offer any investment advise but with the intention of informing audience, and articles in here are of his own opinion. Anyone willing to use any opinion here as advise to invest in crypto should obviously take own responsibility and accountability of their losses (or benefits) thereof. You can reach me at eqariu@gmail.com or david@cryptomorrow.com