All of us are well aware of the fact that cryptocurrency trading is both risky and rewarding. You need to be smart and learn the basics before investing a considerable amount of money on it.
Suppose, you invest $10,000 in crypto and it gets valued to $20,000 in next couple of days! Wow!
But you’ve to understand that there is an equal risk of your investment getting reduced to $100 within days. Don’t be surprised. It’s true.
So, it becomes more important to discuss an important concept in the trading world that can be rewarding, but risky too – Margin Trading. It can be really fruitful if you use it properly to achieve your investment goals.
What is Margin Trading?
Margin trading is the act of borrowing additional money or cryptocurrency by leveraging the existing number of cryptocurrencies you already own for buying additional cryptocurrencies. It is also known as leverage trading or margins. The complete idea behind it is the old age method used in traditional markets.
This concept was born in the US and is practiced in a number of exchanges around the globe. It has been incorporated in cryptocurrency exchanges as well.
Let us consider an example:
You wish to make an investment of $200 in Bitcoin (BTC), but you only have $1000. So, to bring that extra $1000, you borrow that through the margin of 2:1 (2x means for every dollar you have, you will get extra one dollar to invest).
Now, suppose the BTC price increases by 50%, and so is your investment. So, $2000 that you have invested earlier have turned to $3000. You can liquidate it and pay back the debt of $1000 to the lender and enjoy the profits of $1000. This can happen over cryptocurrency exchanges like Tokens.net, BitMax, Kraken, CEX and many others.
But the flip side here is if BTC price decreases by 50%, your investment of $2000 has also abridged to $1000. In this case, the lender needs to be protected and he/she will have the first right to claim your remaining $1000. This means the remaining $1000 will go to the lender. In short, you are left with nothing.
So, you have seen how margin trading can be rewarding as well as risky and this is why it’s not recommended to play with margins until and unless you understand the risks associated with them.
Who provides this extra crypto investment and why?
You might be thinking that who provides this extra money or BTC for margin trading to the trader and why. To make it clear, the individuals or brokers here act as lenders and provide their money or BTC to margin traders at some fee or interest rate.
They agree on certain conditions and whenever the margin trader’s portfolio performs poorly according to those conditions. The broker automatically closes their position saving the lenders so that they get their principal first and then interests.
On other side, if the portfolio of borrower performs well, the lender is paid interests on a regular basis on the said terms.
This is why it is also called leverage trading. Taking an example: If 50:1 leverage means $2000 of equity is required to purchase some order worth $100,000. 400:1 leverage means $250 is required for purchasing an order of $100,000.
There are a number of platforms where you can easily trade your cryptocurrencies and can play on margin trading. Some of them have been mentioned above. I’ll recommend you gaining some knowledge about this form of trading and then only starting with it.
The Bottom Line
If you are a noob to cryptocurrency and trading, I’ll recommend you not to start with it without any knowledge. You should consider the wild volatility of crypto market. This is why it sticks to basic investing principles i.e. never invest more from what you can actually afford. If you are not a margin trader, you should try 1:1 trading at first and then only enter to this rewarding, yet risky form of trading.