What is margin trading?
Margin trading allows you to trade higher amounts than you have deposited on your account, using leverage. Margin is the capital you own, whilst leverage is the tool which allows you to increase your margin., depending how high the leverage is. Margin trading is used in opening both long and short positions.
Example: If a trader wants to open a position at $5,000 with leverage of 20:1, he/she will only need to use $250 of his/her capital.
Initial margin is the capital you need to deposit, to open a position.
Maintenance margin is the minimum amount you need to own in order to not be liquidated if the market is moving in the opposite direction. Collateral and market price both affect the maintenue margin. If the balance of a trader’s margin is lower than the maintenance margin, he/she will be liquidated (see “Liquidation”), meaning all the remaining open positions will be automatically closed.
At CoinDeal Derivatives we use cross margin to calculate your amount needed to avoid liquidation. The term is called cross margin, because we sum up your assets from all the positions.
Besides being very popular in the crypto scene, margin trading is also seen in stock and commodity trading. Nevertheless, due to regulatory restrictions, the maximum leverage is usually lower in stock and commodity trading.
Because margin trading allows you to trade higher amounts than you own, these amounts are normally borrowed. In traditional exchanges, it is an investment broker who will lend his funds. However, in cryptocurrency exchanges, this capital will simply be supplied by other traders (counterparties) earning profit.
The first advantage of margin trading is obviously earning higher profits without putting too much of your own investments in. New traders who do not have too much capital, can easily earn higher amounts in a shorter period of time. Because of that they can be more flexible with opening a lot of positions (with little capital), and then counting their interest one position at a time. However, with big gains also comes the possibility of big losses, and margin trading is no exception to that. Margin trading is considered a high-risk trading strategy, because if you trade with higher amounts than you actually own, your losses are also greater than what you initially invested. The higher the leverage, the higher the risk. For this reason, exchanges like CoinDeal Derivatives strongly urge traders who are fond of leverage, to use stop orders (see “limit, market, stop”).