If you’re looking to trade in crypto but are worried about where you’d get the funds, crypto marginal trading can be the ideal solution.
Also known as leverage trading, crypto margin trading is a widely used practice in the cryptocurrency market wherein you can borrow capital funds from a third party and then invest it in a profitable trade. Such investment can lead to high profits, which can be utilised to gain more returns.
However, no such guarantee exists, and the trade can also result in a loss. Margin trading lets you invest in cryptocurrencies with more money than you currently have, potentially allowing you to increase your profits.
Understanding Margin Trading
A trader uses the margin trading method to buy or sell assets using the funds provided by the broker. In margin accounts, traders are exposed to more outstanding capital to leverage their position accordingly and amplify the trading results, i.e., generate larger profits through successful trades.
For Example
Example:
Consider a trader leverages 5:1 on the account holding $5000, and they borrow 4x the actual amount as a loan, i.e., $5000*4 = $20000, so the current balance is $25000 ($20000 loan + $5000), assuming that Bitcoin price will go up.
As per the trade, there is a 20% increase, so the investment here is worth $30000 ($25000 is the initial + 20% increase of $25000 is $5000 profit = $30000).
After deducting the loan amount from the profit, the trader profits with ($20000 – $30000) = $10000, which comes to a 100% return for investing ONLY $5000.
The above instance can go upside down if the Bitcoin price drops, leading to a 100% loss on the initial investment.
Margin trading is too risky as the market moves quickly, and the trader has to make a strategic move. Under these circumstances, isolated margin vs cross margin plays an important role. Here, an individual can choose whether to invest all the funds as collateral so the losses are covered up with profits or allocate a certain amount as collateral at a specific position.
What Is An Isolated Margin?
In isolated margin mode, the fund allocated as collateral is limited only to a specific position, and the remaining fund is not disturbed by the trade at this particular position.
For example, assume you have 10 BTC in your account overall. You open a leveraged long position because you believe Ethereum’s (ETH) price will rise. You use a 5:1 leverage and set aside 2 BTC as the isolation margin for this particular position.
This allows you to trade 10 BTC worth of Ethereum (2 BTC from your own money and 8 BTC in leverage).
If Ethereum’s price rises and you decide to close the trade, any gain you make will be added to the initial 2 BTC margin you placed. On the other hand, if there is a significant decline in Ethereum’s price, then you’ll lose only 2 BTC.
The remaining eight Bitcoins will remain safe and unaltered, even if the stake is liquidated. This technique is called an isolated margin; it protects the remaining portion of your assets if a particular leveraged deal experiences losses.
Pros And Cons Of Isolated Margin
Pros
- Control over risk: Traders decide how much money they will risk on a given position/trade. This protects the remaining funds by guaranteeing that only the allotted portion is susceptible to losses.
- A clear evaluation of profit and loss: Knowing the precise amount of money associated with each trade makes it easier to compute the profit and loss for each one, giving you a better idea of how well the strategy worked.
- Predictability: Traders may foresee the market movement and the highest possible loss in the worst-case situation by separating funds, which enables more effective risk management techniques.
Cons
- Close observation is necessary: To avoid liquidation, you might need to closely monitor trades because a position is only supported by a percentage of your funds.
- Limited leverage: Trader cannot automatically access the remaining money in your account to stop a transaction from getting unfavourably close to liquidation. More money will need to be manually added to the isolated margin.
- Complex management: Juggling several isolated margins for different trades can be complex, especially for beginners or those in charge of multiple holdings.
Although isolated margin offers a controlled environment for managing risks in leveraged trading, it necessitates close supervision and may limit profit potential if not handled carefully.
What Is Cross-Margin Trading?
In cross-margin mode, all the funds in a trader’s account are allocated as collateral such that the limit of this margin is NOT specific to one position. Therefore, if one position moves against you while the other turns out to be profitable, the profit covers the loss, allowing the position to open longer.
For instance, consider a trader who has 10 BTC and uses cross margin to open a leveraged long trade on Ethereum (4 BTC at 2:1) and a leveraged short one on another cryptocurrency named ‘Z’ (6 BTC at 2:1). Here, the 10 Bitcoin in your account serves as collateral for both trades.
Assume that the price of Z declines and becomes a profit from your short position while Ethereum’s price lowers, possibly leading to a loss; you can utilise the earnings from Z to balance the losses in Ethereum, keeping both positions open.
Conversely, if Z’s price rises and Ethereum’s price falls, both holdings could lose money. If these losses exceed your total account value of 10 BTC, liquidating both positions might mean you lose your entire account balance. The debate between cross vs isolated margin lies at this significant risk factor, where only the 2BTC leverage is under risk if the trader has chosen the isolated margin.
Pros And Cons Of Cross Margin
Pros
- Margin flexibility: Compared to isolated margins, cross margins allow for more flexible margin selection, i.e., choosing multiple positions and effectively utilising available balances across all positions, preventing individual liquidation.
- Position offsetting: Hedging techniques and risk mitigation are easier when gains from one position offset losses from another.
- Reduced liquidation risk: Using more funds to meet margin requirements and leveraging the entire balance minimises the possibility of an early liquidation for a particular position.
- Easy management for multiple trades: Separate margin adjustments for each transaction are unnecessary for cross-margin, making it easier to manage several deals simultaneously.
Cons
- High risk of total liquidation: There is a greater chance of losing the entire account balance if all position losses add up to more than the full amount.
- Less trade control: It is difficult to establish precise risk-reward ratios for individual trades when using shared margin allocation, which restricts control.
- Possibility of over-leveraging: Access to the entire balance could encourage traders to enter more prominent positions than isolated margins, thereby increasing the risk of substantial losses.
The low vision of risks exposed: Risk assessment is complicated while determining the overall risk exposure, particularly when managing various positions with different degrees of profit and loss.
Cross Margin Vs Isolated Margin: The Difference
The cross margin vs isolated margin difference lies in the funds allocated as collateral damage and the associated risk factors. Here are a few concise points of difference between the cross-margin and Isolated margin
- Collateral and liquidation: In the isolated margin, the overall fund is safe in a trader’s account, while only the money allotted for a trade is in danger.
Cross margin, on the other hand, uses the whole balance in your account as collateral for trades. The system can use your entire balance to prevent liquidation if one position turns negative. Yet, the total amount of the account is in danger when several trades experience substantial losses. - Risk management: An isolated margin allows the trader to choose specific amounts for individual trades and separate their influence on your account; an isolated margin provides accurate risk control.
Cross margin, on the other hand, combines risk from all open positions. Although this combined risk is beneficial for balancing many holdings, it also increases the possibility of higher losses. - Flexibility: When trading with isolated margins, adding funds manually is necessary to increase the margin on a particular position.
On the other hand, cross margin provides a more hands-off approach to margin maintenance by automatically using available balances from your account to stop any position from being liquidated. - Trader’s Strategy: For traders who are comfortable with particular transactions and want segregated risk management, an isolated margin is a good option for achieving per-trade risk control.
On the other hand, cross-margin works well for traders with several positions that could offset one another or for those who leverage their entire account and would rather not have to worry about margin maintenance.
Feature | Cross Margin Trading | Isolated Margin Trading |
Collateral and Liquidation | Uses the entire account balance as collateral. | Only the money allocated for a specific trade is at risk. The overall fund is safe in the trader’s account. |
Risk Management | Combines risk from all open positions. | Allows the trader to choose specific amounts for individual trades, providing accurate risk control. |
Flexibility | Automatically uses available balances to prevent liquidation. | Requires manual addition of funds to increase margin on a specific position. |
Trader’s Strategy | Suitable for traders with several positions that could offset each other. Works well for those leveraging their entire account. | It is ideal for traders comfortable with specific transactions, offering per-trade risk control. |
An Example Of Both Isolated Vs Cross Margin
Moving forward, let’s understand a scenario where one can integrate both isolated and cross-margin strategies.
Let’s imagine a trader with a bullish outlook on Ethereum uses an isolated margin to hold a leveraged long position on Ethereum with 30% of your portfolio as a risk hedge. This limits possible losses to 30% if Ethereum performs poorly and presents large profits if it rises.
Using the remaining 70% for cross-margin trading to open a short position for Bitcoin and an extended position for another cryptocurrency, ‘Z’, here the trader believes that ‘Z’ performs well irrespective of Bitcoin’s movements.
This strategy uses potential gains from one position to potential losses from another. If Bitcoin falls (as predicted) during the market shifts, the profits can compensate for any losses from Z and vice versa.
After positions are established, continuous observation is essential. Losses can be minimised by cutting the isolated margin position if Ethereum starts to drop.
Likewise, it seems sensible to alter those holdings if Z significantly underperforms in the cross-margin approach. Isolated vs cross margin influences both trading strategies and might elevate the profit levels from the market predictions, but it doesn’t protect the losses or guarantee profits.
Conclusion
Margin trading is trading assets with the funds provided by the broker or third party. The possibility for increased profits in margin trading is accompanied by increased risk. Depending on the trader’s strategy, risk tolerance, and desired level of position management, they might choose which is better cross margin vs isolated margin.
Understanding the subtleties of various margin kinds is essential in the wild world of cryptocurrency trading. Traders can navigate the volatile crypto market with the help of careful risk management and well-informed decision-making. For traders to succeed, extensive study and consulting a professional before engaging in margin trading is still crucial.
Frequently Asked Questions
What Do You Mean By Leverage?
Using borrowed capital to trade assets is called leverage, allowing you to elevate your buying and selling capacity to trade with more money than you hold in your current account. The leverage amount is usually expressed in ratios. For example, if the leverage is 1:5, it means how many times your initial capital is multiplied, i.e., 5x.
As A Beginner, Which One Should I Use, Cross Or Isolated Margin?
It is recommended to use isolated margins if you are a beginner as the risk of losing funds is lower when compared to cross-margins because only a certain amount of funds is allocated as collateral; therefore, only that particular fund is lost, and the remaining amount is not disturbed.
What Do You Mean By Collateral Funds?
This term refers to the asset kept aside to compensate for the losses that the trades might face when the market moves are against them.
Is Margin Trading Applicable Only To Cryptocurrency Markets?
Margin trading applies NOT only to cryptocurrency but is also incorporated in the international forex market, stock commodities, and traditional markets.
