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Intermediate Guide Introduction to Margin Trading

Discussion in 'Intermediate Level' started by xyzzy, Feb 20, 2018.

  1. xyzzy

    xyzzy Master of None Staff Member Super Admin

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    This is solely an informative introduction to margin trading, for those who hear about it but don’t quite understand it. We will provide more a more in-depth, advanced guide on the intricacies of margin trading in the future.

    What is Margin Trading?

    Simply put, margin trading is when you trade a crypto or stock using someone else’s money that you borrow on interest. You assume the responsibility involved from risking someone else’s money with the advantage of trading with leverage. Standard trades are 1:1 leverage, but margin trading allows you to trade at higher leverages. Meaning if you opened a 2:1 leverage position on a crypto that increased 10%, you actually earn 20%. Pretty sweet right? Well, while margin trading opens opportunities for greater gains, it also opens opportunities for greater losses. If the crypto decreased 10%, you’d see 20% losses. That being said, it is an option for those who have limited personal funds to invest themselves but want to trade with more money (and are willing to assume the risk).

    However, keep in mind: to decrease the risk of the lender losing their money, the margin trader must personally put up a certain amount of his or her own funds as collateral. This means you have to have funds in your margin trading wallet to start margin trading. You will always have to pay back the borrowed amount, and exchanges like Poloniex will try and ensure the lender doesn’t lose their investment.

    Interest rates are daily, which means they can compound very rapidly so it is IMPERATIVE that you verify how much interest you may have to pay. It will depend on how long your position is open, meaning that if you borrow some Bitcoin that has a 2 day duration but close your position after 1 day, you only pay 1 day of interest.

    Compounded daily interest can exponentially stack up over longer periods of time. When you borrow funds from someone via a loan, you agree to return the borrowed money (plus the interest) by a specified date. This makes margin trading more appealing as a short term strategy.

    polo-lending.JPG

    Some exchanges will allow you to margin trade with money borrowed from the exchange. Others, like Poloniex, allow you to margin trade with money borrowed from other investors. If margin trading is too risky for you, you could lend your own money to margin traders to earn some interest. Remember: interest rates on loans are daily.

    When margin trading, there are two positions: short and long. A position will open when you make your first trade. If your first trade was a buy, it becomes a long position. When you sell, your position becomes a short position. Your position will change depending on your trades as long as it remains open.

    As soon as you close your position, the money you borrowed is returned to the lender (including the interest earned), and any additional earnings is given to you, assuming you closed your position at a profit. If you close at a loss, you will have to pay for the lost amount to settle your loan. As I mentioned before, Poloniex will ensure you do not default on your loan via something called forced liquidation, which is an automatic closing of your position to prevent further loss, which is also something to keep in mind when margin trading. Poloniex will give you an estimated price at which forced liquidation will occur, but of course, that is only an estimate.

    All in all, we recommend that beginners avoid margin trading until they’ve built enough confidence and experience with normal trading. Loaning, however, is definitely a viable option, especially for Bitcoin hodlers. Considering Poloniex protects your investment with forced liquidation, risk is minimized. Pretty nifty.

    Happy trading!
     
    Arpit likes this.
  2. Arpit

    Arpit Contributor

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    Excellent article and the way it is put!Short and crisp with numbers.
    Sums up the entire margin trading concept in one article.
    Good for a newbie to get introduced to the concept!
     

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