What’s the Difference between Margin and Leveraged Crypto Trading?
As you become more familiar with the crypto market and trading in general, you will inevitably stumble across the terms leveraged and margin trading. While these terms are interconnected, they don’t mean the same thing. Leveraged trading is a broad term that refers to taking on debt to magnify your exposure to a particular asset. Margin is similar to a security deposit that allows you to borrow money plus an interest payment with the expressed goal to invest in other financial instruments.
Professional traders consider these strategies as an ideal financial tool to further their goals. Both margin and leveraged trading can be used across a variety of different asset classes. Initially, they were used exclusively by expert traders because they simplified their ability to grow their capital exponentially and increase their exposure.
Nowadays, these options are popular with crypto traders. However, since these strategies come with increased risk exposure, it’s common for exchanges to only offer these services to investors who meet certain criteria. Additionally, it’s important to mention that leveraged trading isn’t for everyone. The amount of leverage you utilize should reflect your risk appetite, overall goals, and experience level.
What is Leveraged Trading?
Leveraged trading allows an average investor to take on additional risk with the overall goal to gain greater market exposure for the chance of earning an extra reward. Leveraged trading platforms allow you to invest only a certain percentage of the whole position you desire in a specific asset. The remaining balance is borrowed in the form of the asset from your broker.
Leverage is always expressed as a ratio. This ratio represents the difference between the amount of money possessed versus the amount you can trade. For example, if you entered a leveraged Bitcoin trade with a 100:1 ratio and invested $100, you would control $10,000 in BTC. In this example, all of your trade positions and their profits or losses are multiplied 100 times.
How Much Leverage Can I Get?
Notably, your leverage multiplier differs per market, exchange, and asset. Every broker offers different leveraged trading options, so it’s in your best interest to seek out those platforms that match your risk appetite. In most instances, the amount of leveraged trading options is based on the regulatory conditions that your broker falls under. As such, some brokers are unable to offer these services in their region.
Not a Loan
It’s a common misconception that leverage trading is akin to taking a loan out. A closer examination reveals that there are some significant differences between lending platforms and leveraged trading. Specifically, leveraged traders don’t pay interest on their borrowed funds. However, there is usually some fee required for these services.
Why Trade With Leverage?
There are a lot of reasons why an investor would seek out leveraged trading opportunities nowadays. Primarily, they want to take a more prominent position to maximize returns on price changes. Leveraged traders can increase the value of their trading capital and cash in on even the smallest market movements.
There are a couple of popular leveraged trading strategies in use today in the crypto sector. In most instances, a trader is seeking to leverage short or long. When you short crypto, you take out a leveraged position before the value of the coin drops. Then, you sell your holdings with the intent to repurchase the same coins at a lower value. Since the coins are less expensive when you repurchase them, you can repay your leverage and keep the difference.
When you take out a long leveraged position, you expect the asset to rise in value. In this scenario, you use your leverage to take advantage of extra profits gained from appreciation and strengthened position. When you close your position, you will repay the assets at their original price, leaving you with all the extra profit.
What is Margin Trading
Margin trading is very similar but requires a few more steps. It’s also common for hybrid margin leveraged trading options to be offered. When trading from a leveraged position, your required deposit is also referred to as the margin. When you trade on margin, a broker allows you to borrow at a fixed interest rate with the expressed understanding you will use these funds to invest.
When you trade on margin, you are using leverage because you must only provide a relative amount needed to carry out the actions. The broker will hold your margin as a security deposit. Your margin requirements are subject to change depending on the market conditions.
Like leveraged trading, margin trading is expressed in a ratio. Usually, it’s far less than leveraged trading options. For example, you may enter a margin trade with a 2:1 ratio. If you put up one BTC, you will be lent another one until your position is closed. Unlike leveraged trading, you directly lend this asset with a fixed interest rate and not control it.
A margin call refers to when your broker calls in your position. You will receive a notification by your broker of a margin call whenever your deposit level falls below your leveraged position’s required level. In most instances, this occurs when losses of an open trade position are close to surpassing your used margin.
Depending on your exposure and the platform, the broker can ask you to add more funds to your trading account to continue your position. If you are using a lot of leverage, say like 100:1, it’s common for the broker to close the open position automatically. In most instances, the margin call coincides with you hitting a price where you will start to lose the borrowed funds.
Risks of Margin Trading and Leverage Trading
It’s vital to understand that leveraged trading is a double-edged sword. Sure, you gain the ability to earn a healthy ROI on small price changes, but you also increase your risk exposure significantly, especially when entering a leveraged short.
In most instances, it’s recommended that you utilize minimum leverage until you have reached expert trading status. Also, professionals will tell you that leveraged positions are more dangerous when used in volatile markets, such as cryptocurrencies. Remember, it’s easy to lose more than your initial capital when you trade with high leverage.
Trade with Caution
Now that you have a better understanding of these concepts and how they correlate to your overall success in the market, you are better equipped to decide when and if to apply leverage to your positions. The good news is that more exchanges than ever offer these features. You can trade with leverage or margin at Binance, Bitmex, Kraken, FTX, Bitfinex, and many more.