Bitcoin Margin Trading for Beginners
Margin trading is the process of borrowing money from a broker/exchange to be able to buy a larger amount of an asset than with just your own money. This guide explains how you can do this, and if you should use it for trading Bitcoin/cryptocurrencies.
To limit potential losses, it's a good idea to know how stop-losses work when working with margin. We've posted a guide on this here.
What is margin trading?
There are two terms you need to know about to start:
- When you invest in an asset with fiat (USD), your holdings in that asset are referred to as a position.
- If you want, you can amplify your profit and loss on a position by borrowing money from an exchange; this is referred to as leverage. 2x leverage means your profit/loss is multiplied by 2 (if you invested $100, the exchange would have lent you $100 themselves).
Given the two terms above, if you were to hold a leveraged position on an exchange - this is referred to as a margin trade.
A common question: why would someone lend you money if you might lose it.
The answer: they don't, you pay for all losses on the loaned money. Your gains are amplified by the leverage, but your losses are too; so if your position dropped 50% in value, you'd run out of money and your position would likely be closed. Equally if it went up by 50%, you would have doubled your money. So used correctly you can lose or gain money much faster than a normal trade by taking more risk. This is comparable to gambling.
How does margin trading work?
When first learning about margin, leverage & positions we found it all very confusing, so we'll start with a real-life comparison.
When opening a 2x leveraged long position with $100, the exchange is buying $100 with your money and $100 with theirs. A good way to visualise this is to compare it to real life. If you borrowed $100 from a friend, they'd expect you to pay back $100 regardless of if you earnt or lost money using it. So given you've just borrowed $100, you have $200 in total. If it goes down 50%, it's now worth $100. You need to pay your friend back his $100, so you give it to him and are left with $0. For a 10x leveraged position, your friend lent you $900 giving you $1000 total. If that went down 10%, you would lose $100 and be left with $1000 - which you'd have to give to your friend, and again be left with $0. So if you open a leveraged position and you get it wrong - you lose money faster the higher the leverage. If you opened it at say 100x leverage (never do this for any cryptocurrency!), you'd lose all your money if it dropped 1%.
You'll often see terms like short and long mentioned, but often not explained. To answer a common question straight away, buying an asset is equivalent to a 1x leveraged long position, where you're only using your money. But when using any kind of leverage you're borrowing some.
What is a long position?
A long position is most similar to buying an asset. It means you expect the price of something to go up, e.g. you buy $100 of Bitcoin, it goes up 10% and your $100 is now worth $110 dollars. This is referred to as a long position.
What is a short position?
A short position is more difficult to visualise. You'd use one if you expected the price of something to go down. It works by trading on money borrowed from an exchange. If you knew the price of Bitcoin was about to drop, you could open a leveraged short position by telling the exchange to sell some borrowed money, and buy it back later on. This is essentially the opposite of a buy position, and profit/loss is reversed. So if you opened a 2x short position with $100, if it went down 50% you'd earn $100; if it went up 50%, you'd have lost $100 and the exchange would close your position.
Risks of margin trading cryptocurrencies
The purpose of margin trading is to amplify profit/loss, so if you can predict a price movement you can earn more money. In the stock market this is very common for professionals, as they earn more money than traditional buying and selling. But in cryptocurrency markets it doesn't follow the same rules, there are extra risks that you need to be aware of:
- Cryptocurrency exchanges aren't regulated to the same extent as stock brokers/exchanges. Some aren't at all! This means unlike the stock market, there's much more price manipulation (people controlling the price to earn themselves more money - a practice that's illegal in most countries, but difficult to track in cryptocurrency markets).
- Cryptocurrency markets are similar to penny stocks in terms of volatility, often going up/down in price by 40% or more in a single day. The technology for trading them is also fairly new so there are cases where drops in price of 99.9% have occurred, liquidating (closing) all margin positions open when they happen. This happened on GDAX in June 2017.
- When using leverage on some exchanges, they may not close your positions when you hit a loss of 100%. If you open a 10x leveraged $100 long position and the asset price dropped by 50%, normally this would close automatically when your investment dropped to $0, so after a 10% drop. But if you have $500 in the exchange not invested in anything, it might use this to fund the position for certain order types. This would cause you to lose the $100 you invested as well as another $400. When you first use leverage make sure this can't happen. Open a high leveraged trade of the lowest amount it will allow and, without leaving your computer, make sure it closes when the trade value reaches $0.
Any links to exchanges below are affiliate links, so we'll get some money if you sign up via them.
Best exchanges for Bitcoin margin trading?
If you're investing a large amount of money, CEX.IO is a good place to start for margin trading. It offers up to 3x leverage on Bitcoin, Bitcoin Cash & Ethereum as of writing this (but when we last tested they had quite high minimums, so if you invested say $50 you might not be able to margin trade with it). We're fans mainly because compared to many exchanges CEX has a very user-friendly interface.
If you're a more advanced trader, BitMEX offers much higher leverage (up to 100x). Using leverage this high is very risky, where even a small price movement can cost you all of your money, so only use this if you're happy with this risk. Kraken also offers margin trading, but their user interface is very complex so again we only recommend it if you're an experienced trader.
Conclusion, should you use margin trading?
If you've been trading for years, and have reliably predicted price movements then yes, try using margin trades. Don't use them all the time, just in the cases when you're certain of a price movements (even then, use a stop-loss in-case you were wrong).
If you're reading this guide though, you're likely either new to trading - or just new to cryptocurrency. In both of these cases, no - you shouldn't be using margin. If you were to try your hand at margin and get it wrong, you could potentially lose your entire balance on an exchange. If you were to buy and sell with just your money, regardless of how much it dropped by - even say 90% - if you just hold through the drop, your position would never close unless you told it to or the exchange decided to close down!
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September 16th, 2018
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