Margin Trading: risks and benefits

In this article, we will talk about what is margin trading, which is a very common type of trading.

Sure, this instrument has slightly lost its importance and popularity due to the introduction of futures. Nonetheless, margin trading remains popular among regular traders and professional market participants alike.

To begin, let us define what is margin.

Margin is an amount of funds in a trader’s account balance, used as collateral to open a position.

Specifics of margin trading

In spot trading, you can buy an asset and hold it for however long. No holding fee is charged. On the other hand, in trading on margin, you borrow assets (e.g., stablecoin or a certain amount of coins) from the exchange. Naturally, the exchange is interested in receiving a fee for the loan. Not that exchanges are greedy or something. They just have to, say, pay interest to those who put their coins in staking. And to be able to pay something, they have to earn something. Now, let us get back on track.

The difference between spot and margin trading is more or less obvious. But what about futures trading? At first glance, they hardly differ at all. In both cases, it is common to trade with leverage in both directions. Except, perhaps, the margin leverage for futures is usually higher. Yet, that is not the main difference. Whichever way you look at them, futures are derivative instruments; even if they affect spot prices, their influence is always indirect.

Meanwhile, in margin trading the influence is as direct as it gets!

For margin traders, there are no separate order books, charts, and volumes. Their orders are in the same book as spot traders’ orders. This means that their stops and takes directly affect the price.

Features of margin trading

1. Fee charging interval. For instance, on Binance, margin traders are charged a loan fee hourly, while in the case of futures, the time is usually 8 hours. Moreover, the fee mechanism for futures (called funding) just works differently. While in the trading margin, a loan fee is always charged to the trader, futures traders can actually get paid in case of a position imbalance.
2. The amounts of fees can also substantially differ. They constantly change depending on market events. More about these, as well as about the loan limits, can be learned at the websites of exchanges. Note that even in the case of a good movement in your direction, long-term retention of a position (i.e., over the course of a few months) can sometimes greatly affect your final profit due to the fees charged.

Just as with futures, there are two types of margin in margin accounts:

1. Cross-margin, also known as spread margin, is a type where the entire margin account acts as collateral. This means that assets that can be used as collateral are not confined to USDT, but instead include every kind of asset held in the account (BTC, ETH, BUSD, etc.)
2. An isolated margin means that you have a separate mini-account for each coin you trade. This option limits the risk to assets within a single trading pair.

Benefits of margin trading

• The leverage allows you to enter trades for amounts greater than you would otherwise be willing to.

Leverage is capital borrowed from the exchange in order to open trades for larger amounts and increase the potential profit.

• You can trade with the ALT/BTC pair leverage, both long and short. This can benefit those who intentionally accumulate BTC and seek to increase its amount.
• You can open short or long leveraged positions without having to actually sell the asset (e.g. when using BTC or ETH that you have in your portfolio as collateral for the loan). This only applies to cross-margin.

Drawbacks of margin trading

• Those who fail to observe trading discipline and increase their potential losses risk facing a margin call or, even worse, liquidation of a position (for isolated margin) or of an entire margin account (for cross-margin). Always remember that nobody is immune to mishaps and never put more than 1% of your total capital on the risk for any single margin trade.
• With isolated margin, trading can sometimes get very tiresome: you have to invest in a chosen pair, get a loan, open a trade, close it, and then calculate the amount to be paid back, including fees. All these operations are time-consuming and can be quite challenging to do from your phone.
• In some cases, loan fees for long-term retention of positions on a margin account can significantly exceed those charged for similar futures positions.

Leveraged tokens

This innovative instrument has to do with margin trading, so we cannot leave it aside.

Leveraged tokens are a type of spot-traded assets that allow you to gain leverage exposure without having to provide collateral and deal with a loan account.

Looking at leveraged token charts in PTT (in the pair tree, they are shown in the ETF/STB group), you could have observed that such assets are often subject to huge pricing anomalies. Nonetheless, you should not think that purchase of a token for 5-10 BTC can cause a U-turn in the price of BTC in all pairs and exchanges.

Did you know that on Binance, the underlying asset for leveraged tokens is a futures pair, rather than a spot pair?

This means that what we can see above is a chart for a derivative, and its underlying asset is another derivative calculated based on a spot price.

For this reason, basing your analysis on leveraged token charts it just as wrong as basing it on futures charts and the volumes shown in them.

Conclusion

Margin trading has its benefits and drawbacks. This type of trading is definitely not advisable for beginners who cannot properly assess their risks. Even though in this case the leverage is smaller compared with that in futures trading, the strong volatile movement against your direction puts you at the risk of losing the entire margin deposit. Thus, any potential loss must be limited with stops.

Always remember the basic rule of margin trading:

Leverage in trading is not used to increase gains; it allows you to decrease the amount of your own funds involved in a trade!