Advantages and Risks in Trading

Advantages and Risks in Trading was written by Beastlyorion, and it’s included in issue #6 of 21Cryptos Magazine. To read more articles like this subscribe today. To read other free articles check out our Magazine category. Follow us on InstagramFacebook and LinkedIn.

This article is from an earlier date and as such can contain figures that were actual at time of writing.

So you’ve bought your first cryptocurrency and you think you’ve got what it takes to become a trading legend, but something’s holding you back. Perhaps the lack of funds to make meaningful profits or unfavorable conditions for buyers is keeping you from making the strides that you think you are capable of. Luckily, there is a way to make up for these circumstances through margin trading.

In this article, I’m going to provide some examples to show the advantages and risks of margin trading as well as some common advice, tips, and tricks to give you the edge over your competition and keep you from getting rekt.

Advantages and Risks

Margin trading is the act of borrowing funds to trade with in order to increase leverage in your positions. You can borrow so long as you have the necessary funds available to act as collateral for the loan you’ve taken out with the exchange. As you add more leverage to your positions, the trading decisions you make have an increased impact on your returns, which makes this trading tool both a blessing and a curse. Below are a couple of examples to show what I mean.

Example #1

Say you take a long (buy on margin) position on Bitcoin at $10,000, and in total you want to buy $1000 worth of contracts. In order to do this, you would need to supply over half of the money for your position’s size as collateral (over $500) so that the exchange can trust you with the money you want to borrow from them.

Now you’re trading with $1,000 instead of $500 and the stakes are twice as high. If the price of Bitcoin drops 50% down to $5,000 per Bitcoin, you will have effectively lost all of your $500 that you were using as collateral and the exchange will forcibly close your position (This is known as being Liquidated, aka a Margin Call), whereas before you would be left with $250 worth if you hadn’t used leverage.

On the other side of the coin (no pun intended), if the price of Bitcoin doubles to $20,000, you would be able to close your position for a payout of $1,000 and of course, you get to keep your collateral, which would get you to $1,500 in total.

Example #2

Let’s say you think Bitcoin is going to go down in price and you want to bet on it. Because you are able to borrow more money from the exchange, you are also able to “short sell”, which means to borrow and sell (instead of borrow and buy) and enables you to bet against the market.

If you short sell $1000 using 2x leverage at $10,000 per bitcoin with $500 as collateral and the price drops 50% to $5,000, you would make $500 (50% of $1k) and keep your collateral of $500. This would get you to a total of $1k at the end. On the other hand, if the price goes up 50% to $15,000, you will have burned through your collateral and you would be liquidated.

In conclusion, margin trading is a tool which allows you to increase leverage on your positions, and depending on how correct in your predictions you are, it can have both positive and negative effects on the outcome of a trade.

Advice, Tips and Tricks

Now that you know the advantages and risks of margin trading, let’s go over some advice, tips, and tricks to give you an edge in the market and help keep you from getting rekt.

What Exchange Should I Use?

Bitmex is currently a popular choice for margin trading Bitcoin, Futures contracts on Bitcoin, and a selection of other large cap cryptocurrencies.

Pros

Unlike Bitfinex and Kraken (a couple of other options), Bitmex doesn’t have a history of flash crashes. A flash crash occurs when there are large liquidations and no limit orders for those liquidations to sell into. This sets off a chain reaction that can leave people forced to cover their positions at insanely low prices, sometimes even $0. In my opinion, this is just plain theft caused by the negligence or maliciousness of the exchange, and for this reason, I do not use or trust exchanges which are prone to flash crashes.

Bitmex is one of the best functioning crypto exchanges I’ve used. It has had very few outages in my experience and relatively low lag during high price volatility.

Cons

One of the downsides to Bitmex is that it requires a Bitcoin deposit instead of a deposit of other coins, or even fiat.

Bitmex has yet to implement Segregated Witnesses for their wallet, so expect very high transaction fees (often over $50) when you withdraw.

Risk Management

You’ve probably heard it a thousand times while reading about trading, but when it comes to leveraged positions, it is even more essential that you are aware of what you are risking when you open a position. Even though you are utilizing money that you don’t have initially, I recommend not opening any positions larger than what you would normally open without leverage. Use leverage to help put small sums of money to big use, not to put big sums of money to massive use.

How Much Leverage Should I Use?

I highly recommend sticking to 1-10x leverage. Keeping the leverage as low as possible while keeping your position size effective will keep you from getting liquidated. Personally, I never open positions over 10x leverage.

If you open a position on 10x leverage, you’ll have a 10% cushion on your trade before you burn through your collateral and get liquidated.

If you open a 100x leverage position and the price moves even 1% against you, you will be liquidated. Keep the leverage modest, especially until you feel comfortable and know what you’re doing.

Initial Margin and Maintenance Margin

Something you should be aware of when opening leveraged positions is the initial margin and maintenance margin that the exchange you are using requires.

The exchange will require a certain amount of extra collateral when opening a position in order to assure that if your position is covered far above or below where your liquidation price was (this can happen during times of very high volatility), that the exchange can claim the extra collateral as compensation. I recommend reading up on your exchange’s rules in their FAQ section.

Always Set a Stop-Loss

The worst feeling in trading comes from being liquidated on a heavy position. Ensure that it never happens by setting stop losses on your trades. If you get really good at margin trading, this might even allow you to sleep while you have highly leveraged positions open. Save yourself the agony of losing everything you have on the exchange by setting a stop loss.

Always Follow the Trend

While margin trading, it is essential that you are aware of the time frame you are trading on, where you want to open and close your positions, and where you are going to call it quits if the price moves far enough against you (setting a stop loss). Try to ensure that you are opening your position at the most optimal price and with the highest possible certainty of success by following the trend on as many time frames as possible.

Bitcoin has been in a long term bull trend since its inception, so it would stand to reason that you would have been more likely to succeed in going long than going short over that time frame. Now that you know the bigger trend, you can move to a lower time frame and determine the trend on a weekly, daily, hourly, and even by the minute (for the true degens out there) charts. The swings on the weekly/daily/ hourly are strong enough that playing the swings on those time frames is arguably the best way to go.

Catch the Dips/Sell the Peaks

When you’re margin trading, every percentage gain and loss matters. Try your best to catch the bottom of the dips before the trends align bullish or sell the peak before the trends align bearish on the time frame that you want to play.

I like to use The Stoch RSI indicator to help with this. It is a momentum indicator that works on all time frames.

For a position that you want to keep open for 1-3 days, try to wait for when the 4h, 1h, and 15m time frames are all oversold, the daily Stoch RSI is moving upwards, and resistance is about to break. If you are bearish, try to sell when the Stoch RSI is overbought on those time frames and support is about to break.

As much as traders like to talk on Social Media about the massive gains they’ve made via margin trading, it is not as easy as it might seem. Trading by itself is already extremely risky, so throwing extra leverage on top of the most volatile market amounts to the most challenging and rewarding method of trading in the world.

If you are looking to start margin trading, start small with minimal leverage and work your way up to the level where you feel both challenged and comfortable at the same time. Good luck out there, you trading degenerates!