Understanding Crypto - Margin Trading

First things first - this article needs a disclaimer. A lot of people do not understand margin trading and enter the market with just a vague idea of what it is. Then they get in big, big trouble. What we are going to discuss here is in no way an invitation to start margin trading or a tutorial on how to do it. If this is the first time you are reading about margin trading, you are not ready to do it at all. This article is just here to inform you of what margin trading and leverage are so that you understand it when it comes up in a conversation. That is all.

What margin trading is, in short, is trading with borrowed money. You create a trading account and deposit money in it. As an example, if you deposit 1000 dollars in your margin account, you are able to buy 2000 dollars worth of coins. 1000 with your own money and 1000 with the money the brokerage loans you. It is important to understand that it is loaned money to help you have higher earnings, but as always, it only works out great if the price grows.

Example

Your account gives you 4:1 leverage. That means that if you invest 100 dollars, you can borrow 400. Four times as much as you have already invested. Let us imagine that you know that ExampleCoin will rise in value. You are 100% certain of it and want to get big money, but you feel that you do not have enough. One ExampleCoin now costs 10 dollars. It will cost 20 dollars tomorrow, you are sure of it. If you invest 100 dollars, then tomorrow you can take out 200 dollars (as you can see, we are going to ignore transaction fees.) And that is all fine and dandy, but you want more.

You create a margin account and deposit said 100 dollars. That allows you to borrow 400, so you invest all 500 dollars. You have now bought 50 coins instead of 10. The next day comes, a single ExampleCoin costs 20 dollars. You sell all 50 of them and now you have 1000 dollars. You pay back the 400 you borrowed and you are left with 600 dollars, by investing just 100. Now, this example also ignores trading fees and the fees you pay to the brokerage for borrowing the money. We will get to that a bit later.

Drawbacks

Remember, no such thing as free money. Whenever you think that you have a 100% bet to make money, always remember how many people have been burned while they were just as certain as you are now. Investing in crypto is always a gamble. Margin trading? It is like gambling while you are already gambling. Like taking out a loan to bet on chips. Just a dangerous move overall.

It is basically for people who know what they are doing and can use it wisely. Many folk borrow money even if they have the funds themselves, they just feel more comfortable depositing small sums in an account. Many use these accounts to make smarter plays, use complicated strategies and make sophisticated bets that are counterintuitive to beginners. Or some think that their money could be used in other investments at the time. Still, all smart men have funds ready in case the position they have made with a margin account turns sour.

So never consider this as a way for “poor people to become rich”. Not a loan to be taken out when “times are tough”. The second you have that thinking, you have already lost. A better way to look at this is when you consider it as a loan taken out by big companies like Apple or Amazon. Look at how much money they own, how huge are their debts. Are they in debt because they are poor? Not at all. They are in debt because “debt” for them is just another way to manage money. A place to get income they can experiment with and invest in new things, but rest assured - if they fail, they will always be able to repay the debt. And that is the way of thinking you have to have to margin trade.

Margin Call

Now, you bought 50 ExampleCoins, 10 dollars each. You have invested 100 of your own money and 400 you borrowed. The problem is that the price did not rise to 20 as you predicted, but fell to 5. And now you’re in trouble. If you were to sell all your ExampleCoins now, you would have 250 dollars. And you have to pay back the 400 you borrowed, but not only that. Usually, when you borrow money, you have to pay an additional sum for the privilege, a fee.

That means that you have invested 100 dollars, but instead of just losing 100 dollars, you have lost all your money and you owe 150 to the brokerage. 150 plus all the fees of the brokerage of your choice. And this is not going to happen on your terms either. If the price of your assets falls to a certain level, you are going to get Margin called.

A margin call is when the brokerage sees that you are in the red and it decides to act with your assets. As you have borrowed the money, those assets are not entirely yours, in a way. The brokerage can decide that it is going to sell your assets to cover the losses. It will always offer you the option to deposit more money to cover the margin, of course, but if that fails, your funds are forcefully liquidated.

How to choose a brokerage?

While we know that folk are sick of hearing this, but this has to be stated again and again - the world of crypto lacks regulation. Especially the US market is plagued with uncertainty and is the real wild west, with exchanges unsure what to do and restricting margin trading in times of volatility or not allowing it at all. So we will not name any specific exchanges, as times change fast these days. Instead we will just point out some of the basics to look out for.

Check out the fees. Again, different strategies are fit for different fee systems. Some exchanges take a percentage all the time when your position is active, while others just look at the prices at the end and take a percentage out of them. This, coupled with all other fees, almost always will be the determining factor when you choose an exchange. Still, always remember - if the offer seems to be too good, it is. Always look at reviews and do your research. Is the exchange reputable or is it just something that has popped up yesterday and promises you instant gold? Beware.

Then take a look at the pairings where margin trading is possible. There is no need to register and complete the KYC requirements if the pairing you are looking for is not available. Or maybe the pairing is there, but no liquidity at all. At the same time, do not look for the highest leverage possible. Start small, then grow bigger, that is the only smart way.

Alternatively you could look into one of those leverage demo accounts that are available in some exchanges. Just a place that is to be used as a training ground where you can see what would have happened to your bets if you were to place them in real time with real money. It is always better to check your strategies in a demo environment before you go out in the big world and try to get that big money you’ve always dreamed about.

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