By Terry Ashton, updated July 1, 2024

In recent years, margin trading in cryptocurrency has been taking over the trading scene as more and more traders jump into this arena instead of standard spot trading. If you’re wondering what all the buzz is about, margin trading lets you borrow money to increase the size of your trades, aiming for bigger profits.

It sounds exciting, right? Well, it can be, but it’s not without its risks. With the promise of amplified gains also comes the potential for significant losses, and that’s where things get tricky. In this article, we’re going to break down the pros and cons of trading crypto with margin, helping you decide if it’s the right move for you.

What is margin trading in cryptocurrency?

Margin trading in cryptocurrency allows traders to borrow funds to increase the size of their trading positions. Essentially, you’re using borrowed money from a crypto margin trading exchange to trade larger amounts of crypto than you could with your own funds. This technique can potentially amplify your profits if the market moves in your favor, but it also increases the risk of larger losses if the market goes against you.

In the context of cryptocurrency, margin trading works by using a portion of your funds as collateral to borrow additional funds. For example, if you have $1,000 and want to trade with leverage of 10x, you can control $10,000 worth of cryptocurrency.

Leverage is the key concept in margin trading. It refers to the ratio between the amount of capital you invest and the amount you borrow. A leverage ratio of 10:1, or 10x, means you can trade ten times the amount of your own capital.

Several exchanges offer margin trading for cryptocurrencies. Some of the most popular ones include Binance, Bitfinex, Kraken, and Coinbase Pro. These platforms provide various levels of leverage, ranging from 2x to over 100x, catering to both conservative traders and those seeking higher risks and rewards.

Pros of trading crypto with margin

Increased profits

One of the biggest attractions of margin trading is the potential for increased profits. When you trade with leverage, you’re essentially borrowing funds to amplify your trading position. This means that even a small increase in the price of a cryptocurrency can result in significant gains.

For example, if you have $1,000 and use 5x leverage, you can trade with $5,000. If the price of the crypto you invested in goes up by 10%, your profit would be $500 instead of $100, significantly boosting your returns. Statistics show that traders using leverage can see up to 10x higher returns compared to those trading with their own capital.

Access to larger positions

Margin trading allows you to access larger positions than you could with your own capital alone. This means you can take advantage of more significant market movements and opportunities.

For instance, if you spot a promising trade but only have limited funds, using margin can enable you to enter the trade at a much higher value. Imagine you have $2,000 and use 3x leverage, suddenly, you’re trading with $6,000!

Advanced margin strategies

Crypto leverage trading strategies are notably different from standard spot market strategies due to the additional risks and complexities involved. In spot trading, you buy and sell cryptocurrencies directly using your own capital. The primary focus is on buying low and selling high, with risk management centered around stop-loss orders and portfolio diversification.

In contrast, leverage trading introduces the concept of borrowing funds to increase your market exposure. This not only amplifies potential profits but also magnifies losses. Margin trading strategies require a deep understanding of market dynamics, precise timing, and rigorous risk management, see this guide for more advanced crypto leverage trading strategies.

Here are some key advanced strategies:

1. Swing trading with leverage

Swing trading involves holding positions for several days to weeks to capture price swings. With leverage, swing traders can amplify their gains during these periods. Key aspects include:

• Technical analysis: Using charts and indicators to identify potential entry and exit points.
• Market sentiment: Understanding the broader market trends and news that could impact prices.
• Risk management: Setting tight stop-loss orders to limit potential losses.

2. Arbitrage trading

Arbitrage trading involves taking advantage of price differences between different exchanges or markets. With leverage, traders can increase their capital efficiency and profit margins. This strategy requires:

• Fast execution: Speed is critical to exploit arbitrage opportunities before they close.
• Low fees: Choosing exchanges with low transaction fees to maximize net profits.
• High liquidity: Ensuring sufficient liquidity to execute large leveraged trades without slippage.

3. Hedging

Hedging involves taking an offsetting position to mitigate potential losses in your primary investment. For instance:

• Long/short positions: If you hold a long position in a volatile cryptocurrency, you can open a short position using leverage to hedge against price drops.
• Options and futures: Using derivative contracts to hedge positions, requiring knowledge of contract specifications and expiration dates.

4. Scalping

Scalping is a high-frequency trading strategy that aims to make small profits from minute price changes. Leverage enhances the profitability of each trade. Essential elements include:

• Quick decision-making: Scalpers must make rapid decisions and execute trades within seconds to minutes.
• Automated trading: Utilizing trading bots to capitalize on fleeting opportunities and manage multiple trades simultaneously.
• Strict discipline: Adhering to a predefined trading plan and avoiding emotional trading.

Short selling

Margin trading also allows you to profit from declining markets through short selling. Short selling involves borrowing a cryptocurrency and selling it at its current price, with the intention of buying it back at a lower price. If the market price falls, you can repurchase the asset at the lower price, return it to the lender, and pocket the difference. This ability to bet against the market can be a valuable tool in a trader’s arsenal, especially during bearish market conditions. In fact, during the 2018 crypto market crash, many savvy traders used short selling to profit while the market was tumbling.

Enhanced liquidity

Having access to greater funds through margin trading can improve your trading liquidity. This means you can enter and exit trades more easily without significantly impacting the market price. Enhanced liquidity can lead to more efficient trading and better execution of your trades, allowing you to capitalize on market opportunities more effectively.

Cons of trading crypto with margin

Increased risk of loss

One of the biggest drawbacks of margin trading is the heightened risk of losses. While leveraging your trades can amplify your gains, it can also magnify your losses. For example, if you use 10x leverage and your trade moves against you by just 10%, you could lose your entire investment. This is because the borrowed funds need to be repaid regardless of whether your trade is successful.

Margin calls and liquidation

Margin calls and liquidation are significant risks associated with margin trading. A margin call occurs when the value of your account falls below the required maintenance margin, which is the minimum amount of equity needed to keep your position open. When this happens, you’ll be required to either deposit more funds or liquidate your position to meet the margin requirement.

If you fail to do so, your broker can close your positions, often at a loss, to prevent further decline in your account value. This can be financially devastating, especially if the market moves rapidly against your position. It’s like getting a call from your bank saying, “Remember that money you borrowed? We need it back… now!”

Interest and fees

Borrowing funds for margin trading is not free. Traders must pay interest on the borrowed amount, and these costs can add up quickly, especially if you hold your positions for an extended period. Additionally, there may be other fees associated with margin trading, such as commission fees or account maintenance fees.

Emotional and psychological stress

Trading with margin can be emotionally taxing. The higher stakes involved can lead to increased stress and anxiety, as the potential for both gains and losses is amplified. This emotional pressure can result in poor decision-making, such as panic selling or holding onto losing positions for too long in the hope of a rebound. Managing stress and maintaining a clear, rational mindset is crucial for successful margin trading, but it can be challenging, especially for new traders.

Complexity

Margin trading is more complex than regular trading and requires a deep understanding of market mechanics and risk management. Traders need to be well-versed in technical analysis, market trends, and the specific rules of margin trading platforms. Without a solid foundation of knowledge, it’s easy to make costly mistakes. The steep learning curve can be a barrier for many, making it essential to educate yourself thoroughly before engaging in margin trading.

Key areas to focus on include:

• Technical analysis
• Market trends
• Platform-specific rules

Potential for overtrading

With access to more funds, there’s a temptation to trade more frequently, known as overtrading. While it might seem like a good idea to capitalize on every market movement, overtrading can lead to higher transaction costs and increased risk exposure. It’s important to have a disciplined trading strategy and stick to it, rather than getting caught up in the excitement and making impulsive trades. Overtrading can deplete your account quickly, especially if you’re not careful with your leverage and risk management.

Wrapping up

In summary, trading cryptocurrency with margin offers both exciting opportunities and significant risks. On the plus side, margin trading can lead to increased potential profits, greater flexibility, and the ability to diversify trading strategies. It also provides opportunities for short selling, enhanced liquidity, and hedging.

However, these benefits come with considerable downsides. The risks include amplified losses, the possibility of margin calls and liquidation, interest and fees, emotional and psychological stress, and the potential for overtrading.

Most traders make the mistake of entering the market with proper training. Don’t make the same mistake. Use a crypto margin trading exchange that offers a demo account where you can practise without risk.