Margin trading, whether in stocks or cryptocurrencies, involves traders using borrowed funds, known as a margin loan, provided by exchanges or occasionally by other users. Like any loan, the trader must provide collateral, typically a deposit ensuring repayment according to exchange rules. The trader’s own funds allocated to open such a transaction are called the margin, hence the name. This approach enables users to potentially profit more than they would solely with their own funds, thanks to leverage.
Positions in margin trading are typically divided into long and short. In a long position, the trader expects the asset’s value to increase, while in a short position, the trader bets on its decline. Brokers provide traders with credit based on leverage when opening positions. If the asset price moves as predicted, the trader’s potential profit increases in line with the chosen leverage. Upon closing the position, the pledged amount is returned to the creditor, along with commission fees, while any profit is credited to the user’s account. Some exchanges also impose funding rates, paid by holders of long and short trades, depending on the number of open positions.
Margin trading offers both advantages and disadvantages. Leveraging increases profit potential, with the higher the leverage, the greater the potential profit or loss. It allows traders to profit from falling asset prices, diversifying their strategies. Additionally, it enables hedging against potential losses by investing in assets inversely correlated with the primary investment. However, margin trading carries significant risks, including the obligation to repay borrowed sums and high risks of losing the initial margin. Furthermore, exchanges may limit the assets available for leveraged trading to mitigate potential losses, especially for inexperienced traders.
In summary, while margin trading can amplify profits, it requires careful management and financial knowledge due to its inherent risks and complexities.