What Is Margin Trading?

Author: nicolas tang

margin trading

What is Margin Trading?

Margin Trading and Leverage are interconnected concepts, as borrowed funds are often used to create more leverage on trades. To learn more about Leverage, please view What is Leverage Trading?

Margin trading is when a trader is allowed to borrow some funds from the liquidity providers so as to carry out trades of any size irrespective of his or her account balance. The liquidity providers in exchanges are investors who deposit funds (either in terms of cryptocurrencies like Bitcoin or in terms of fiat currencies like US Dollar) with the exchange so that the funds can be used by others for a given duration of time.

Let us take an example: A Bitcoin trader wishes to purchase 5 Bitcoins anticipating that the price of Bitcoin will rise so that he or she can sell the Bitcoin at a higher price in the future. But the trader does not have enough money to purchase the entire 5 Bitcoin. So, he or she can choose to use the margin facility to borrow the required amount to purchase the 5 Bitcoins.

Terms and Concepts associated with Margin Trading:

Terms and concepts commonly associated with Margin Trading include:

  • Buying Power: the number of funds plus leverage that an investor can use to buy securities. When using leverage, this amount will always be larger than the actual account balance.
  • Coverage: is a fundamental indicator that investors should always be aware of. It represents the ratio between the net account balance and the leveraged amount, or the amount that will eventually have to be paid out.
  • Margin Calls: If an investor’s leveraged asset is not performing well and its value drops below a certain acceptable level determined by the lender, they will issue a Margin Call asking for additional funds to be deposited. If the investor fails to deposit such funds, all positions will be closed.

To learn more, read the list here: Terms and concepts associated with Margin Trading

What is Margin Trading in Bitcoin futures?

Bitcoin futures trading has grown to be one of the most sort after cryptocurrency derivatives trading. Since its introduction, there has been an influx of players in the market sending Bitcoin futures prices higher daily.

In Bitcoin futures trading, the amount of margin for most contracts is normally below 10% of the total value of the contract. However, this percentage varies depending on the exchanges. For example, CME requires traders to use a 35% margin and Cboe requires traders to use a 44% margin, calculated from the daily settlement price.

How does it work?

Buying on margin is borrowing money from a broker in order to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you’d be able to normally. To trade on margin, you need a margin account This is different from a regular This is different from a regular cash account in which you trade using the money in the account.

The flip side of Margin trading

When a futures contract that was traded using margin is closed, the amount borrowed plus any accrued interest is first paid. This amount is reimbursed regardless if the trade made a profit or a loss. Therefore, margin trading is a two-edged sword. Though it assist traders to hold larger trades than they would probably have placed without the margin, if the trades make losses, the margin makes the loss larger due to the accrued interest.

Some exchanges also require a maintenance margin which normally caters for the losses. If the maintenance margin is depleted, the account holder is given a margin call, where his or her position is closed since the trader does not have sufficient funds to pay the liquidity providers if the loss becomes larger.

 

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