What is Margin Trading or Leverage?

Margin trading or trading with leverage is a form of trading where the positions you take are leveraged by the broker or platforms you use to participate in the markets. This with the aim of multiplying the profits that you can have with your successful operations, but at the same time, multiplying your chances of losing everything. 

SIf you have participated in the world of trading you will surely have seen the term margin trading or leverage. This is a trading method with which we can make use of funds provided by a third party, which is generally the trading platform we use. The purpose of this is to strengthen our position and thereby generate higher profits from our operations.

Thanks to this, margin trading accounts allow traders to obtain larger sums of capital, allowing them to take better advantage of their positions. However, this ability to expand the capital at stake is dangerous, because just as it can generate very good profits, it can also generate large losses and debts.

Despite this, these tools have become very important, not only in traditional markets, but also in cryptocurrency markets. Due to this we want to dedicate this space to understand how margin trading works, what are its advantages and what is the best way to use these tools.

How does margin trading work?

First you have to understand that this functionality is not in almost any exchange, only in some. In exchanges that do have this functionality, when you want to operate by performing a margin trading operation, you must commit a percentage of the total value of the order that you are going to create.

For example, if you want to create an order of € 10.000, committing € 2.000 of your capital (margin), the platform must have the ability to leverage your position (give you a loan) of 5x to reach the total order you want to place. If the platform accepts your conditions for leverage, then you will have successfully performed a margin trading operation, and the success and failure of your position will depend on the market and your study of it.

At this point, if you win the position, you will make profits as if the € 10.000 of the position were your property, from there the platform will divide the profits for you and the platform. This is the happy ending, to put it one way. However, if your position loses, all the money that you have put in the position will be lost, and for this you only have to lose a fifth, since you are leveraged at x5.

This second option, unfortunately, is the most common option, given that the volatility of the cryptocurrency market is high, and it is extremely easy to be tempted by large leverages and with it that our operations are closed losing everything in just a few hours.

Leverage levels

Of course, the above is a very simple example to understand how margin trading works. The reality is that each trading platform or broker that supports this functionality has its own rules on how they apply margin trading, and especially the margins and leverage levels that they allow their users on the trading pairs that have assets.

In fact, leverage levels are one of the most variable points in margin trading. For example, in the stock markets it is normal to see leverage from 2x to 5x. In the futures markets you can usually see leverage from 15x to 25x. On the other hand, in the currency markets it is not uncommon to see margin trading with 200x leverage, which gives us an idea of ​​how these markets are managed and the leverage possibilities that exist in each of them.

The same thing happens in the cryptocurrency markets. In these markets the most common leverage ranges from 5x to 10x for the most important trading pairs, especially those of Bitcoin. But there are platforms that offer leverage of even 100x as is the case with Bitmex.

Types of Operations

Unlike traditional markets, margin trading also allows you to earn money when the price of something falls, that is, to open short operations (sale of an asset due to a fall in value), in addition to the normal, long operation (purchase of an asset by rise in value).

On both occasions, the trader's margin remains locked as a guarantee for the borrowed funds. This guarantee allows trading platforms to close positions without losses involving their borrowed funds. But instead, the escrow funds are liquidated, causing the trader to lose the entire position.

Many traders, especially those starting out in the world of trading, see this as unfair. However, it is understandable that the platform protects your investment and in case your operation goes to loss, settle it saving your funds. This action is known as "margin call" and it is the worst thing that can happen to a trader who makes use of margin trading. This means that the bet that you have not only was not successful, but that you have lost all the money put in the position. But if on the contrary, the operation is successful, you will obtain the profit, multiplied by the leverage.

This point is essential to understand, and it is also important that you know that each platform has its own rules for leverage or margin treatment, among other things. So, if you decide to take the step, despite all the risk it entails, the first thing you should do when entering this world of margin trading, indisputably, is to carefully review the conditions of the exchange where you want to operate.

Example of a margin trading operation

Below we will detail a simple example of margin trading so that you better understand how it works:

Daniel is trading a BTC / USD pair and has a total of € 10.000 in his possession. It detects that the market is going up, the price of which is currently € 9500 BTC. Daniel believes that the price will continue to rise, he is very convinced, and therefore wants to open a long trade (buy). However, despite how convinced he is, he only wants to bet € 5.000 and is so convinced that the price is going to increase that he wants to leverage, choosing a leverage of 10x.

In this way, Daniel takes € 5.000 and puts it as his margin (guarantee for leverage) in the operation. This allows you to open a long position with a total of € 50.000 (€ 5000 x 10 = € 50.0000), equivalent to approximately 5,26 BTC.

Once his position is open, Daniel waits for it to culminate within the parameters he has entered. To be more precise, Daniel believes that Bitcoin is going to reach € 9650, which would generate a profit of approximately € 789.

Two things can happen at this point:

If Daniel's position wins, his exit will be € 50.789 obtaining the expected profit of € 789 in a single trade. That profit will be distributed as a percentage both for the platform (for being a lender) and for Daniel. The percentages vary according to the platform. But if he loses, Daniel will have lost his entire position (or a significant part of it). And to lose everything, it will only be necessary for Bitcoin to go down € 1.900 (a fifth of € 9.500)

If Daniel had carried out this operation without margin trading, his profits would have been much lower, in fact they would only have been € 78. And in case of going bad Bitcoin should reach 0 to lose everything.

Hence, margin trading tools attract a lot of traders attention in order to obtain better profits. However, these can also lead to a lot of losses because no one can know whether Bitcoin will go up or down for sure.

Pros and cons of margin trading

Among the pros of margin trading we can highlight:

1. It allows you to obtain higher profits for the trading positions that are made.
2. The trader can diversify his positions a little better and leverage each of them. This situation can offset the risks of losses from your trades by offsetting them against each other.
3. It is possible to open large positions without having to have large amounts of money on the exchanges. This is especially useful on cryptocurrency exchanges, where the platform could be attacked by hackers.

On the other hand, its disadvantages include:

1. It can lead to big losses. Exchange platforms with margin trading options can settle trades at a loss. Therefore, when making the “margin call” this may mean the total loss of said margin. There is even the possibility of losses that exceed the margin entered by the trader, leaving you with a debt.
2. It is not a tool for beginners or medium users. In markets such as cryptocurrencies, the high volatility of assets makes these operations especially risky.