Spot Trading vs Margin Trading
If you are interested in trading cryptocurrencies, you may have come across two terms: spot trading and margin trading. These are two different types of trading that involve buying and selling crypto assets.
In this article, we will explain what they are, how they differ, and what are the advantages and disadvantages of each.
What Is Spot Trading?
Spot trading is the simplest and most common form of trading. It is your normal buying and selling, where you pay the full price of the asset and take delivery of it. For example, if you want to buy one Bitcoin at $30,000, you need to have $30,000 in your account and you will receive one Bitcoin in your wallet. Similarly, if you want to sell one Bitcoin at $33,000, you need to have one Bitcoin in your wallet and you will receive $33,000 in your account.
Spot trading is straightforward and easy to understand. You own the asset that you trade and you can profit from its price movements. However, spot trading also has some limitations. You can only trade with the funds that you have in your account, which limits your potential profits. You also need to store your crypto assets securely, which may require a hardware wallet or a trusted custodian service. Moreover, you can only profit from rising prices, not from falling prices.
What Is Margin Trading?
Margin trading is a more complex and riskier form of trading. It is a form of leverage, where you borrow money from a third party to enter larger positions and potentially amplify your profits or losses. Margin trading allows you to trade with more money than you have in your account, by using a fraction of your own funds as collateral.
For example, if you want to buy one Bitcoin at $30,000 with 10x leverage, you only need to have $3,000 in your account and you can borrow $27,000 from the exchange or another lender. This means that you can control a larger position with a smaller amount of money.
If the price of Bitcoin goes up to $33,000, you can sell it and make a profit of $3,000 (minus interest and fees), which is a 100% return on your initial investment of $3,000. However, if the price of Bitcoin goes down to $27,000, you will lose your entire investment of $3,000 (plus interest and fees), which is a 100% loss on your initial investment.
Margin trading is more complicated and risky than spot trading. You do not own the asset that you trade and you have to pay back the loan that you borrowed. You also have to maintain a minimum margin level in your account, otherwise you may face a margin call or liquidation. A margin call is when the exchange or the lender asks you to deposit more funds or reduce your position size to restore your margin level. A liquidation is when the exchange or the lender automatically closes your position at a loss to prevent further losses.
Margin trading also has some advantages over spot trading. You can trade with more money than you have in your account, which increases your potential profits. You can also profit from both rising and falling prices, by going long or short on an asset. Going long means buying an asset with the expectation that its price will increase. Going short means selling an asset with the expectation that its price will decrease.
Margin Call and a Liquidation
When you trade on margin, you need to be aware of two events that can occur when your margin level falls below a certain threshold: a margin call and a liquidation. These events are triggered by the exchange or the lender to protect themselves from your potential default on the loan that you borrowed.
A margin call is a warning that your margin level is too low and you need to take action to restore it. Your margin level is the ratio of your equity (the value of your collateral) to your used margin (the amount of money that you borrowed). For example, if you have $10,000 in your account and you borrow $90,000 to buy one Bitcoin at $100,000, your margin level is 10% ($10,000 / $100,000).
Different exchanges and lenders have different margin call levels, but they are usually between 20% and 50%. If the price of Bitcoin drops to $95,000, your margin level will drop to 5% ($5,000 / $100,000), which may trigger a margin call. A margin call means that you need to either deposit more funds or reduce your position size within a specified time frame (usually 24 hours) to increase your margin level. If you fail to do so, your position may be liquidated.
A liquidation is a forced closure of your position at a loss to prevent further losses. Different exchanges and lenders have different liquidation levels, but they are usually between 10% and 20%. If the price of Bitcoin drops to $90,000, your margin level will drop to 0% ($0 / $100,000), which will trigger a liquidation. A liquidation means that you lose your entire collateral ($10,000) and any remaining loan balance ($90,000). You may also incur additional fees or penalties for liquidation.
Margin call and liquidation are two events that you want to avoid when you trade on margin. They can result in significant losses and damage your trading account. Therefore, you should always monitor your margin level and use proper risk management techniques such as stop-loss orders or hedging strategies.
Spot Trading vs Margin Trading: A Comparison
Conclusion
Spot trading and margin trading are two different types of trading that involve buying and selling crypto assets. Spot trading is simpler and safer, but also more limited in terms of potential profits. Margin trading is more complex and risky, but also more flexible and rewarding in terms of potential profits.
The choice between spot trading and margin trading depends on your personal preferences, risk appetite, and trading goals. If you are new to crypto trading or prefer a low-risk approach, spot trading may be more suitable for you. If you are experienced in crypto trading or prefer a high-reward approach, margin trading may be more suitable for you.
However, regardless of which type of trading you choose, you should always do your own research, follow the market trends, and use proper risk management techniques. Trading crypto assets can be profitable, but also volatile and unpredictable. Therefore, you should only trade with money that you can afford to lose and never trade more than you can handle.
