Margin Trading: Learning about Risks and Benefits
Dubai, UAE, 11th April 2024, Cryptocurrencies have significantly impacted the financial sector, introducing modern trading methods that are more advantageous than traditional finance. Margin trading is one phenomenon that enables crypto traders to increase their potential profits considerably and get closer to their financial goals at a quicker pace. Let’s explore it in more detail.
Examining Margin Trading
Various lending platforms allow traders to borrow extra crypto funds by depositing collateral. Traders can choose to allocate a certain collateral amount for each trade or utilize all funds in their accounts. In the first case, called isolated margin, a trader allocates a fixed collateral amount for one position, limiting possible losses. This approach simplifies the calculations, thereby attracting many traders.
In the case of cross margin, traders benefit from more flexibility. When using this approach, the system will automatically utilize any available balance within the account to avoid liquidation of any open position. This way, you can keep both profitable and loss-making positions open for more extended periods, increasing your chances for positive outcomes. The cross-margin method is often used with hedging.
Risks & Difficulties
Margin trading can be extremely profitable, but it also involves substantial risks, one of which is amplified losses. Suppose a trader decides to use 5:1 leverage to trade Bitcoin; their profits will be five times higher than those based solely on their own capital. However, the same is true for losses. Sometimes, these losses may be very severe, especially when traders use additional loans to prolong their positions beyond margin calls.
The risk of significant losses is connected to margin calls, prompted when the value of a trader’s assets plummets below a level supported by the collateral. When that happens, the trader can put in additional funds to maintain the position, or it will be liquidated. Another problem with margin calls is that some lenders may close all of a user’s open positions, including profitable ones that could have grown for a more extended period. To worsen the problem, liquidations are typically carried out at any given price. Consequently, traders can bear even greater losses after liquidations in a highly unstable or illiquid market.
Another difficulty that awaits margin traders is the complexity of real-life trading scenarios and corresponding calculations. Trading profits can be affected by fees, borrowing interests, market volatility, etc. So, it may be hard for beginners to predict trading outcomes and allocate funds efficiently. Such complexity often prompts traders to seek assistance from specialized software, necessitating a certain level of experience.
How to Minimize Risks
One of the most effective ways to minimize risks is to adopt robust risk management practices, like setting stop-loss orders and limiting the size of leveraged positions.
The next step towards ensuring safety is having sufficient capital to support its position when needed. Therefore, using only a portion of your funds is more reasonable as it will help you have adequate funds to cover margin requirements and prevent inconvenient liquidations.
Another noteworthy consideration is to hedge your positions to minimize risks as much as possible. Hedging refers to taking a position opposite your original one, thereby offsetting any probable losses. However, this approach is also quite tricky to do right, so try to explore this option in more detail before trying it out.
Next, using specialized bots or other tools that can promptly analyze the market and automatically exit trades if necessary can benefit all users. Such tools will help you make decisions calmly and act quickly.
The final safety measure is regular monitoring. You should always check your trades since not all platforms will notify you of margin calls. Moreover, staying updated on major market developments and news will enable you to make necessary adjustments before any margin calls pop up.
Final Thoughts
Margin trading in the crypto market gives traders a bigger chance of generating higher profits. However, it is also associated with considerable risks that traders must consider thoroughly and learn how to tackle effectively. Kinetex can assist you on your crypto journey, offering instant cross-chain swapping of thousands of supported crypto assets.
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Disclaimer: The views, suggestions, and opinions expressed here are the sole responsibility of the experts. No Digest Pulse journalist was involved in the writing and production of this article.