{"id":195983,"date":"2021-07-30T13:43:47","date_gmt":"2021-07-30T12:43:47","guid":{"rendered":"https:\/\/cryptoslate.com\/?p=195983"},"modified":"2021-07-30T16:38:37","modified_gmt":"2021-07-30T15:38:37","slug":"beginners-guide-to-margin-crypto-trading","status":"publish","type":"post","link":"https:\/\/cryptoslate.com\/beginners-guide-to-margin-crypto-trading\/","title":{"rendered":"Beginner\u2019s guide to margin trading cryptocurrencies"},"content":{"rendered":"

In 1940, the chances of children outperforming their parents in terms of income was 41%. In 1980, this decreased to 8%, according to Opportunity Insights<\/a>. Given the current inflation trajectory followed by wide-scale suspension of economic activity throughout 2020, it seems likely that social mobility compared to previous generations will continue to decline.<\/p>\n

One way in which this trend can be combated is through investing in deflationary assets<\/a> \u2013 such as some cryptocurrencies. Unsurprisingly, younger generations, led by millennials, are at the forefront of crypto adoption.<\/p>\n

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Image credit: Bitcoin.com<\/figcaption><\/figure>\n

There are many ways one could 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 beyond. This form of investment, which is based largely on timing, minted many crypto millionaires. In May of 2021, there were about 100,000 BTC addresses<\/a> with over $1 million worth of Bitcoin.<\/p>\n

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Image credit: nasdaq.com<\/figcaption><\/figure>\n

Seeing such a rapid rise in wealth of so many, there\u2019s 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, drawing its root all the way back from the late 1800s as a way to bankroll railroads. As we fast-forward over 120 years, let\u2019s take a look into how margin trading works in the crypto space.<\/p>\n

What Is Margin Trading?<\/h2>\n

Margin trading is leveraging your market position to reap greater rewards with a small initial investment. This is possible by adding a collateral called margin \u2013 the funds you borrow from a third party (brokerage or exchange) \u2013 to your trade. However, in the same way your leverage can bring about X times profits, it can also incur devastating losses if the asset\u2019s price defies your expectations.<\/p>\n

In practice, if you were to margin trade $50 worth of BTC for a 5X leverage, you would borrow $200 to buy $250 worth of Bitcoin (BTC). Therefore, your effective trade with which you would enter the market would be at $250 instead of $50. In turn, no matter how the trade pans out, you would have to return $200 + the platform\u2019s fees.<\/p>\n

If a crypto\u2019s price move goes wrong \u2013 down instead of up since you entered your position \u2013 the crypto exchange will \u201cmargin call\u201d your trade when the price hits a level when you start losing borrowed funds. To avoid getting margin calls, and having your trade turn into a loss, you would have to keep adding funds above that level.<\/p>\n

When you bet that the crypto\u2019s price will go down, you enter a short position. Correspondingly, when you bet that the crypto\u2019s price will go up, you enter a long position. In the crypto space, margin trading is especially risky because crypto assets are inherently volatile. After all, they all hold relatively low market capitalizations (compared to the traditional stocks, that is) which makes it more likely that crypto whales can move prices to their benefit. For example, Bank of America recently estimated<\/a> that it would take $93 million to move the price of BTC by 1%.<\/p>\n

According to Tim Fries, co-founder of financial education platform The Tokenist, margin calls bear significant risks<\/a>. Whenever a margin call cannot be met, many traditional stock brokers have the right to close out other open positions held by the investor, in order to meet the minimum amount in the leveraged position. Fries explains:<\/p>\n

\u201cMargin calls could end up costing you a huge amount in short-term capital gains tax, as well as unrealized profits from investments that are showing signs of recovery or further growth.\u201d<\/p><\/blockquote>\n

For this reason, it is prudent to start your margin trade small \u2013 under $100 \u2013 and increase by fractions. Likewise, you should have a clear plan for when to exit the market and take the profit. Many traders become too greedy and want to test the volatility beyond the point of profit. More often than not, there is a price reversal and the investor must cut their losses instead.<\/p>\n

Margin Trading in Practice<\/h2>\n

Although exchanges have different interfaces and styles, you will notice they all have the same key elements:<\/p>\n