Margin trading is a method of borrowing third-party funds to conduct asset transactions. Margin trading accounts give traders access to more capital than regular trading accounts, allowing them to use leverage for their positions. In essence, margin trading amplifies trading results and increases the gains traders make on profitable trades. With this characteristic of amplifying trading results, margin trading is popular in low-volatility markets, especially international foreign exchange markets. This approach is also widely used in the stock, commodity and cryptocurrency markets.

In traditional markets, funds borrowed by margin exchanges usually come from investment brokers. However, in cryptocurrency trading, this part of the funds is usually provided by other traders, who charge a certain amount of interest on the margin based on market demand. Additionally, there are a handful of cryptocurrency trading platforms that offer margin to users.

How does margin trading work?

After starting margin trading, traders need to pay a certain proportion of the total value of the order. This initial investment is called "margin" and is closely related to the concept of leverage. In other words, a margin trading account is used to create leveraged trades, where "leverage" refers to the ratio of borrowed funds to margin. For example, to establish a trade worth $100,000 with a leverage of 10:1, the trader needs to pay a principal of $10,000.

Of course, different trading platforms and markets have different rules and leverage. The stock market usually sets a leverage of 2:1, while futures contracts are usually traded with a leverage of 15:1. Forex brokerage companies usually set a leverage of 50:1 for margin trading, and in some cases it can reach 100:1 and 200:1. In the cryptocurrency market, leverage generally ranges between 2:1 and 100:1. The trading community often uses the term "x" to refer to leverage (such as 2x, 5x, 10x, 50x, etc.).

Margin trading can be used to open long and short positions. Long positions reflect bullish market sentiment, while short positions do the exact opposite. When opening a position using margin trading, the trader's assets act as collateral for the borrowed funds. Traders must understand this because most brokerage firms reserve the right to force the sale of a trader's collateral if the market moves against the trader's position (above or below a certain threshold).

For example, if a trader establishes a long leveraged position and the price plummets, the system will require him to make a margin call. A margin call is issued when a trader must fund a margin account to meet minimum margin trading requirements. If the trader fails to inject capital, the held assets will be automatically liquidated to cover the capital loss. Generally speaking, this happens when the total value of all assets in a margin account (also known as "liquidation margin") falls below the total margin required by a specific trading platform or broker.

Analysis of advantages and disadvantages

The most obvious advantage of margin trading is that the relative value of the trading position is large, which can be Investors create huge returns. Secondly, traders can use margin trading to open multiple positions with a relatively small investment principal to obtain diversified investment opportunities. Finally, traders with a margin account can quickly open a position without transferring large amounts of money into the account.

Although the advantages are obvious, the amplification effect is a "double-edged sword". When losses occur, margin trading amplifies them in the same way, making investors worse off. Unlike conventional spot trading, losses caused by margin trading may exceed the trader's initial investment and are recognized as high-risk trading methods. Depending on the leverage used in trading, a small drop in market prices may also result in huge losses for traders. Therefore, investors involved in margin trading must follow sound risk management strategies and utilize risk mitigation tools (such as limit-price and stop-profit orders) to reduce risk.

Margin trading in the cryptocurrency market

Intrinsic aspects of margin trading compared to regular trading The risk is greater. When combined with cryptocurrencies, the risk is doubly amplified. The cryptocurrency market is volatile, and margin traders in this space must be extra careful. While hedging and risk management strategies may play a role, margin trading is certainly not for beginners.

Analyzing charts, identifying trends, and determining buy and sell price points does not eliminate the risks involved in margin trading, but it can help predict risk accurately and conduct trades efficiently. Therefore, before using leverage on cryptocurrency trading, users are advised to first develop a keen understanding of technical analysis and gain extensive experience in spot trading.

Margin Fund

For investors who are unable to bear the risk of margin trading, they can choose another method to make profits through margin trading. Some trading platforms and cryptocurrency exchanges provide a "margin fund" function, allowing users to inject funds into other users' margin transactions.

This process usually follows specific terms and results in a dynamic interest rate. If the trader agrees to the terms and accepts the offer, the fund provider has the right to repay the loan with agreed interest. While such mechanisms may vary from exchange to exchange, providing margin funds to other users is relatively low risk given that leveraged positions can be forced out to avoid excessive losses. Additionally, margin funding requires users to deposit funds into the trading platform wallet. Users must consider the risks faced and understand how this feature works in their chosen trading platform.

Summary

For users who expect to double their profits, margin trading is indeed a very practical tool. If used properly, the leverage trading provided by a margin account can effectively increase profitability and diversify your investment portfolio.

However, as mentioned above, this type of trading may lead to liquidation and carries huge risks. Therefore, it is only recommended for skilled traders. Due to the volatility of the cryptocurrency market, caution should be exercised when engaging in margin trading.

Read our Binance Margin Trading Guide to learn how to participate in margin trading.