Margin-trading is an important tool that all of us should understand to know if we should implement it or not, and how to do it. The use of leverage and short position has the potential to dramatically increase the profitability of a wide range of different strategies, as well as unlocking many opportunities that would not otherwise be available.
However, failing to fully understand what exactly margin-trading is and how to use it, many mistakenly associate margin-trading with risk, when in fact it is an essential tool for professional and institutional investors.
In this guide, I'm going to delve into what cryptocurrency margin-trading really is, how to implement it, what is leverage, short position, the best ways to use margin-trading, and obviously the ways to avoid the risks involved in margin-trading.
What is Margin-Trading?
Margin-Trading is a set of tools that allow us to increase the opportunities available so that we generate greater profits.
The margin-trading process consists in that we receive a loan from a broker, and that loan allows us to create investments that would not normally be within our reach, but that have the potential to generate significant amounts of profits.
Margin-trading has grown in the cryptocurrency market in recent years, and more and more investment platforms are incorporating it into their services in response to investor demand to explore new ways to increase their profitability.
Margin-trading is a term that encompasses two different but similar tools that we can use to increase our profits: leverage and short position.
What is Leverage?
Leverage is the process by which an investor borrows funds from a broker in order to create significantly larger investments than he could make with his available capital.
As part of this process, we as investors will provide an amount of our own capital, known as the margin, to ensure the leverage operation. This margin is used in case the operation results in losses instead of generating profits.
Due to the mechanics of leverage, the profit generated by the operation can be substantially greater than that which would occur with a normal investment, since it can multiply what would normally be earned with it.
Let's see a concrete example of this: if we believe that the price of Bitcoin will increase and we put a trade with 10X leverage in Bitcoin, for every dollar that we would have generated normally we will get 10 if the price of Bitcoin actually increases.
What is Short Position?
Similar to leverage, the underlying principle in short position involves an investor borrowing funds from a broker. However, the objective of the short position is to make a profit if the price of an asset falls, rather than if it increases.
This is achieved when an investor borrows from a broker an amount of an asset that he believes will lose value, sells it immediately, waits for the price of the asset to drop to an acceptable level, and then buys the same amount of the asset back at a lower price. You can then return it to the broker and keep the difference as a profit.
This would be a concrete example of a short position. We may think that the price of Ethereum is going to drop sharply, so we borrow a quantity of Ethereum from an investor and sell it immediately. The price of Ethereum then drops 10%, and then we buy back the same amount 10% cheaper, we return it to the broker and we keep 10% of the difference in its price as a profit.
The ability to use the short position in the cryptocurrency market opens up a wide range of opportunities that are not normally available without this option. This means that if the price of an asset falls, a profit can also be generated.
What are the Best Ways to Use Margin-Trading?
Flat Trend Leverage
One of the best and most undervalued ways to use margin-trading in the cryptocurrency market is to leverage relatively short movements during flat trends and their consolidation.
While for many investors the only chance to make a profit is when prices move widely higher or lower, the opportunity to make a profit during flat periods is often offset by the risk of having to predict sharp short-term swings.
However, a problem can arise when a flat trend lasts for a long time and an investor is out of the stock during that period, meaning that they cannot make a profit until an uptrend or downtrend forms.
One way that margin-trading can help open up many more profit-making opportunities in the cryptocurrency market is by using leverage during flat periods to make relatively small moves up or down more profitable.
With the use of the short position to be able to invest during downtrends, and the use of leverage to engage with profitability during flat trends, we can now generate profits in the cryptocurrency market without exclusion.
Go Short on Spikes and Excess Purchases of Assets
Spikes are rapid short-term increases in the price of a cryptocurrency that occur frequently in the market, and present a wide range of different opportunities.
One of the best strategies to use margin-trading to create situations where there is an increased probability of making a profit is to go short on rallies, and also when crypto assets are overbought.
According to the mean-reversion theory, when a crypto asset moves far away from its historical average price, there is a greater probability that it will return to its mean at some point in the future.
From a psychological perspective, when the rally occurs there are a significant number of investors who will be holding the asset to make a short-term profit.
Consequently, it is logical that when they have the opportunity to generate that profit they will, and this will cause a chain reaction where the price of the asset falls to where it was before the rally.
When the rally has been identified, it is possible to short the crypto asset at its highest point, and when the asset price falls, close the position and make a short-term profit.
Going Long in Bullish Periods
Unlike other financial assets, the cryptocurrency market has an inherent mechanism in the way that Bitcoin works, known as the 'halving cycle', which implies that every 4 years the amount of Bitcoins generated by the miners.
Due to the artificial shortage programmed in the way Bitcoin works, since the rest of the cryptocurrency market more or less follows the price of Bitcoin, this means that every 4 years there is a rapid increase in the value of the cryptocurrency market, known as a bull period.
While large profits can be made simply by buying cryptocurrencies at the start of a bull period and holding it for the duration, astronomical profits can be made using leverage long during these periods.
At no other time does the cryptocurrency market present a better opportunity for profit generation than leveraging a long position just before a bullish period.
What are the Risks of Margin-Trading?
Use a Stop-Loss
Some investors associate margin-trading with risk, particularly with leverage, and, while it is true that they do involve certain risks, there are a number of mechanisms available for investors to avoid this risk and keep their potential profit generation intact.
One of the most widely used and best known risk avoidance mechanisms is the use of a stop loss, which is executed when the price of an asset moves too far in the opposite direction from what was expected.
When that limit is reached, the order is automatically executed and closes the position to protect the investor from incurring further losses, effectively ending the trade.
It is highly recommended that investors using leverage also include the stop loss to ensure that if the trade goes in the opposite direction than expected, it is stopped at the threshold and prevents the investor from losing the entire balance you have.
Inefficient Use of Capital
Many investors often spend months or even years in the cryptocurrency market before accumulating enough knowledge to be able to develop strategies to generate profits on a regular basis.
When an investor has developed a strategy that reliably guarantees profits, all the profits generated can be significantly amplified using leverage, and this is by far the most efficient way to use capital, as opposed to leaving profits on the table for not using margin-trading.
One of the great risks that cryptocurrency investors face is the inefficient use of their capital by not using leverage to amplify the benefits they are already generating, settling for much smaller returns.
For example, if an investor has a strategy that consistently generates a profit of 10% per month, and has invested $ 1,000 in this strategy, he will generate a profit of $ 100 per month.
If you used that $ 1,000 every month and leveraged it up to 50X, you'd generate $ 5,000 a month in profit with just $ 1,000 of capital.
Use Maximum Leverage for All Trades
Another risk investors need to be aware of is using maximum leverage in all trades, rather than calculating a balanced way to implement leverage based on each situation.
Professional investors go through a process of assessing the risk of each situation before designating how much leverage they will use on each trade, to make sure they are protected.
If a trade has a high risk factor, then using less leverage will ensure a greater margin for error, whereas if the investor has calculated that the risk of a trade is low, then it makes sense to use higher leverage to try to secure a higher return on investment.
Margin-trading is a powerful tool for beginners to open up new opportunities to generate profits, and to protect their capital in the cryptocurrency market.
While many retail investors lose the opportunity to use margin-trading in their daily activities, it is an essential tool used by almost all professional investors for the efficiency it offers in the use of capital.
Although many investors only perceive the risks involved in margin-trading, this is only part of the equation, and it is important to consider the different ways in which margin-trading can reduce as well as increase their risks, and the different tools. mitigation tools that investors have at their disposal.
Finally, I would like to clarify once again that the purpose of my articles is always informative and educational, and I tirelessly recommend that you do not take any word as sacred and infallible.
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