MARGIN TRADING explained for newbies, noobs, new traders.

Hello All

I've noticed that margin trading questions keep popping up on this forum and there seems to be a lot of misconceptions, misunderstanding regarding this issue as well as just lack of knowledge. I totally understand this as I struggled to understand margin trading and the issues surrounding it when I first started to trade, so a helping hand from me to those learning to trade and wanting to know more and understand margin trading.

I will provide an analogy in regards to MT (margin trading), in a way that hopefully makes sense to you as it did to me.

I'm sure you have probably you have heard that MT amplifies your gains and losses. Lets see how purchasing with and without MT effects your account balance and the risks and rewards involved with MT.

The analogy I am going to use is the purchase of a house using a loan/mortgage, as the principle is similar to trading crypto with margin. This is a transaction many of us make in some points of our lives so understand it better.

You decide to buy a house worth 100k. Your bank requires a 10% deposit (10k).

You are therefore looking to buy this house on ratio of 10/1 (or another way of saying it is on a leverage of 10/1)

If the bank had required 20% you would be buying at a ratio of 5/1 (leverage of 5/1).

Your initial deposit (or MARGIN) for the house is 10k and this is what your bank requires and will use as a risk mitigating factor to avoid its potential loss on its loan to you (expained later).

lets say your house price after a few months after purchase has increases by 10% to 110k.

So your initial investment was 10k and your house has now risen in value by 10k. You have therefore made a 100% profit (ROI) on your initial capital investment if you were to now sell the house. Hoorayyy you have made an awesome investment.

If the house had risen by 1% or say 5% (to 101k or 105k) you would have made a profit/return on investment (ROI) of 10% (1k) or 50% (5k) on your initial investment of 10k.

Now Lets look at if you purchased the house with no loan from the bank (NO deposit/margin) using a full 100k you had saved from work.

Again the value has increased by say 1%, 5% or 10% to (101k or 105k or 110k). The profit you have made would have been either 1k, 5k or 10k. So a ROI of 1%, 5% or 10% on a 100k initial investment. You can immediately see even though your returns were the SAME! your ROI was way LESS with this method of purchase due to the larger amount of capital you used to purchase the house.

Now lets look at the opposite scenario.

The house price starts to decline for whatever reason.

You purchased on a leverage of 10/1 (10k yours 90k bank).

a 1% decrease (house price 99k), 5% decrease (house price 95k), 10% decrease (house price 90k).

If the above scenarios occurred you would have lost 10%, 50% or a total loss of 100% respectively on your initial capital of 10K!!! damn wiped out completely with 10% move against you so no more buying for you!!!

If you had used NO money from the bank and purchased the house with 100k of saved funds.

a 1%, 5% or 10% decrease would have reduced your capital investment by 1k, 5k or 10k respectively, therefore you would be left with 99k, 95k or 90k.

Below is the loss you would occur if you have used different leverage (borrowing ratios) and subsequently (DIFFERENT deposit/MARGIN allowance amounts) with a 10k investment and the price decreases.

10/1 (10k yours 90k bank) 1% decrease =1k loss=10% loss on initial investment=9k
50/1 (2k yours 98k bank) 1% decrease =1k loss=50% loss on initial investment=1k
100/1 (1k yours 99 bank) 1% decrease=1k loss=100% loss on investment=0

As you can see in the third scenario a 1% decrease would have wiped out 100% of your 1k deposit/margin allowance due to the highly borrowed ratio (leverage) amount.

The BIG question most ask is what happens if the decrease in value is more than your initial investment!!!!. Well let me tell you something, before that even happens the bank will forcefully sell the property as soon as the decrease is close to (60/80%) your initial investment amount and will certainly avoid ANY LOSS to their balance sheet and borrowed amount. To add insult to injury, they will return a small balance leftover (usually not very much at all after they have taken all their fees to sell your house in an emergency).

Lets now look at a different scenario and say you want to purchase flats worth 30k each instead of a house, and the bank still lends at a ratio (leverage) of 10/1. The bank therefore requires a 3k initial deposit (or margin required) per flat (3k yours 27k bank).

With your initial 10k you can purchase 3 flats on 10/1 leverage and still have 1k left over.

You have now made multiple purchases using your same 10k deposit and are still looking for another investment for your 1k that is remaining.

Now relating the above to trading crypto using margin. The principle is exactly the same, you are borrowing to buy or sell a larger position using a small deposit in your account (margin allowance). You can open one position or multiple positions depending on the leverage you use and an amount from your account will be used as a deposit by the exchange (or otherwise known as USED MARGIN ALLOWANCE allocated to that buy or sell position by your exchange). If the position moves against you significantly (60/70% decrease), you will receive a margin allowance call (the exchange WARNING you) to say your allocated MARGIN/deposit is low according to their requirements. They will allow you do close the position or ask you to increase your MARGIN/DEPOSIT by adding more funds

BTC is currently at $8300, to buy or sell 1 full BTC

a 5/1 position will require $1660 as your margin deposit (20% negative swing in price for total loss of funds)
a 10/1 position will require $830 as your margin deposit (10% negative swing in price for total loss of funds)
a 50/1 position will require $166 as your margin deposit (2% negative swing in price for total loss of funds)
a 100/1 position will require $83 as your margin deposit (1% negative swing in price for total loss of funds)

A LIQUIDATION will occur when the exchange forcefully sells your position due to insufficient margin/deposit in your account for that position you opened that has moved against you significantly, and therefore the exchange recovers their borrowed funds from you. You will get liquidated before you reach a complete loss (known as bankrupt price).

Margin trading is something all professionals use and is a step up from normal trading. As you can see you can buy (go long) or sell (go short) on a larger position using a small amount.

Most professionals usually DO NOT RISK more than 5% of their TOTAL account per trade. Your risk/loss tolerance should be strongly taken into account when margin trading.