A contract between many parties that is predicated on the fundamental value of a financial asset is known as a derivative transaction. The value is based on a broad range of financial instruments as the underlying assets, including shares, currencies, commodities, indices, futures and options contracts, and stocks.
Because those engaged in derivatives trading do not own the underlying asset, they are gambling on its potential price changes. This makes derivatives trading distinctive.
Additionally, about the price of an underlying asset, this kind of trading permits traders to have both long and short positions. For traders, companies, and even governments who would be hedging against an existing position they may already have, this is advantageous.
Margin Trading
Derivative trading offers investors the opportunity to increase their market exposure beyond the money that is accessible in their trading accounts.
Traders can open trades with just the necessary margin investment, depending on the leverage level that is being supplied. Because they offer liquidity, margin traders are seen as essential to capital markets, along with speculators and arbitrageurs.
Derivatives Trading and Leverage
The benefit of trading derivatives is that you may position yourself on a financial instrument for a fraction of the price of the underlying asset by leveraging leverage. The relationship between the total amount in a trading account and the amount you can trade with is known as leverage.
A trader executing a deal needs just 1% of the total value or margin when the leverage ratio is 100:1. For $10,000, a trader might purchase fifty $200 contracts of crude oil futures. This implies that all they have to do to fund their trading account is $100.
Is trading on the margin the same as trading with leverage? Is a margin account regarded as leverage? Can a trade be leveraged without using margin?
Although there are typically minor distinctions between several crypto terminology, they may also be used interchangeably. Leverage and margin trading are two excellent examples. Although you would believe that the two are interchangeable, there are a few subtle differences to be aware of, as we’ll discover in the piece that follows.
Margin cannot be discussed without mentioning leverage, and vice versa. Ideally, margin is required for leverage trading to function, and leverage is required for margin trading to function. Furthermore, to employ both trading techniques profitably, one must be aware of the distinctions because both involve a higher level of risk exposure.
A synopsis of margin trading and leverage trading for cryptocurrency is provided here, along with a summary of some of its primary advantages and some helpful reminders for users.
Benefits and Drawbacks Come with Margin Trading
Increasing your purchasing power with a loan from the exchange is how margin trading operates. Increasing prospective returns is the main goal here. Let’s take a quick look at some advantages and disadvantages.
Advantages of margin trading
- Portfolio diversification: You can afford to own a variety of assets thanks to your improved buying power, which helps to diversify your holdings.
- Greater possibility for profit: If the trade works out well, your purchasing power will allow you to take on bigger positions, which might result in higher profits.
- Reduced interest: Even if you had to pay back the margin that was given to you, the interest you would have paid would still be far less than if you had taken out a loan and traded with cash.
- Short selling: Unlike spot markets, which restrict long positions, margin trading permits both long and short positions in the market, enabling profit in both bull and downturn markets.
Disadvantages of margin trading
- Risk of portfolio liquidation: The exchange may liquidate your whole position if the market moves against you and your account is below the maintenance margin. Margin trading regulations vary throughout cryptocurrency exchanges and trading platforms, and breaking them will lead to liquidation.
- Losses are amplified: Increased purchasing power equals more potential losses if the deal does not go as planned.
- Interest: The loaned margin will be subject to interest payments from you. It is a drain on your prospective earnings even if it is far smaller than in other markets, and it incurs additional costs if your transaction is unsuccessful.
- Risk of margin calls: In a market as erratic as cryptocurrency, brief swings may cause your account to go below the maintenance margin, in which case you would receive a margin call. But you could tolerate brief price swings if you were dealing with full cash.
Advantages and Disadvantages of Leverage Trading
Margin trading and cryptocurrency leverage trading have comparable benefits and drawbacks.
Advantages of leverage trading
- There is a greater chance of making noticeably more money because of the expanded market exposure.
- Loan repayments and interest combined: The gains you make in leverage trading are entirely your own, unlike margin trading.
- Leverage trading lets you trade cryptocurrency derivatives, which lets you trade in any kind of market. You may easily acquire or short-sell a certain cryptocurrency by trading cryptocurrency futures.
- With little funds, you may trade a variety of cryptocurrencies, therefore diversifying your transactions.
Disadvantages of leverage trading
- Magnified losses: Trading with leverage also increases the possibility of suffering losses. Let’s take an example where you are trading with a 10X leverage. A one percent loss in the market is equivalent to ten percent in your trading account. Additionally, the inherent volatility of the cryptocurrency market makes it easy for your account to be destroyed.
- Longer-term traders might not be good candidates for leverage trading. Leverage trading is best suited for traders with short time horizons, whether they are day traders or intraday traders.
Can a Trade Be Leveraged Without a Margin?
No. Margin and leverage trading are closely related. The first money you put into your trading account is called margin, and it’s what you use to trade with leverage. Trading with leverage requires a margin. You are unable to use the leverage without it. Having a margin account gives you more purchasing power. You can trade larger positions than the amount of capital in your account when you use leverage.
Recall that leverage is nothing more than your capital multiplied, giving it additional buying power. The most important thing to remember from this is that leverage provides more purchasing power for your holdings, while margin is the cash needed to access it.
Conclusion
Despite their close relationship, margin trading and leverage trading are not the same. Margin trading is borrowing additional money from the cryptocurrency exchange to trade with, using the capital that has been placed into your trading account.
Contrarily, leverage trading entails leveraging a credit line that the best derivatives trading platform offers to you to increase the size of your position. Leverage in this context refers to the rise in the buying power of your capital or the deposited margin.
