Are you frustrated and stuck in determining what’s margin trading is? You might agree with me when I say, future trade is a tricky job compared to spot trading.
In this article, we will discuss what’s margin trading is, trading on leverage and what’s the difference between leverage and margin. Let’s start!
What’s Margin Trading?
Margin trading is also known as leveraged trading or contracts for difference (CFDs). Margin trading is often widely used in foreign exchange market transactions to magnify the profits from small price movements in currency pairs. The foreign exchange market usually allows users to use high leverage.
Margin trading allows users to open positions larger than available capital. In favourable circumstances, users earn higher profits than if they did not use leverage.
Trading on Leverage
Leverage is the ratio of the amount that can be traded to the amount necessary to open a position. Leverage can sometimes be expressed as a ratio, such as 100:1, or as a multiple, such as 100X.
Suppose the price of Bitcoin is $10,000.A user has $1,000 in Bitcoin (0.1 BTC) in his account and wants to open a buy position with 100x leverage. In short, traders can multiply 0.1 BTC by 100. It means he has the opportunity to open a buy position worth 10 BTC or $100,000.Transaction size is also known as notional value.
If the price of Bitcoin rises to $10,500, users can close their positions for a profit of $5,000 and get their original funds back. As a result, the user’s funds are increased by 5 times. Conversely, if the Bitcoin price drops from $500 to $9,500, users will lose their entire $1,000 position.
If a user opens a position without using leverage, they need to deposit the full $100,000 or 10BTC to get the same amount of market risk.
Leverage vs Margin:
When learning how to use leverage, you will almost certainly come across the term leverage vs margin. In short, while leverage and margin refer to the ability to magnify your bets, they mean two different things.
In terms of leverage, this is expressed as a multiple (e.g. 5x) or a ratio (e.g. 1:5). However, margin refers to the amount you need as a security to get your desired leverage ratio/multiplier.
- Suppose you are trading ETH/USD.
- You want to bet $100 and apply the leverage of 1:10
- It means your trade value has increased from $100 to $1,000
- In turn, the margin requirement for this trade is 10%
A further example:
- Suppose you are trading XRP/USD
- You want to bet $500 and apply 1:5 leverage
- This means your trade value has increased from $500 to $2,500
- In turn, the margin requirement for this trade is 20%
It is important to understand what’s margin trading is; if you don’t know about margin before trading, you will bear a big loss.