Margin trading example
Margin trading is the practice of buying or selling an asset with borrowed funds while the asset itself serves as collateral against your debt and can be sold (bought) to repay it.
Example: you have $1,000 in your account and can borrow up to twice the amount you have, this is referred to as having x2 leverage on your position or 50% margin, where $1,000 is borrowed, and $1,000 is the margin. At the price of $500 per BTC you can buy two bitcoins with your balance, but with x2 leverage, you can buy four bitcoins for $2,000, so if the price goes up, you make more profit on your initial $1,000 investment. However, if the price goes down twice to $250, your four bitcoins have to be sold back to repay your $1,000 loan, and you left with nothing.
Note, that you don’t have to use full leverage allowed to open a margined position, you could borrow only $500 (x1.5 leverage), or $200 (x1.2 leverage), or any sum up to the twice the amount you have in your account. If you don’t want to use any leverage, you open a position only with $1,000 you have, which would make your leverage x1 (100% margin).
Trading futures on margin
The trick with trading futures on margin is that no actual borrowing is needed to open a margined position. Since non-deliverable bitcoin futures contracts are just an agreement between two parties (long and short) to pay each other the price difference of the contract value in the future, they can provide only the amount which is sufficient to cover this difference and not the whole cost of the contract. The absence of borrowing is the reason why trading fees are much less when compared to spot trading. Let’s take a look at an example to understand this concept more clearly.
Each okex.com bitcoin futures contract is worth $100, and they allow you to trade with up to x10 leverage (10% margin). Suppose each bitcoin is worth $1,000, and you decide to open ten long contracts. Ten contracts at $1,000 per BTC are worth precisely one bitcoin ($100*10 = $1,000), but you only have 0.2 BTC in your account, so you open x5 leverage position, with 0.2 provided as a margin (1/0.2 = x5). What do we have now:
Entry price: $1,000 BTC/USD
Position worth: 1 BTC ($100 * 10 = $1,000)
Margin: 0.2 BTC
Leverage: x5 (1 BTC / 0.2 BTC = 5)
If the price moves against you to around $840 BTC/USD, your total losses will be nearing the size of your margin (0.2 BTC), and you will have to close your position since you have almost no funds left to keep paying your obligations on these contracts. If you don’t close your position, it will be automatically closed (liquidated) by the trading engine of the exchange. Essentially these contracts are passed to someone else who’s willing to take the long side, but now with the lower price compared to your entry (around $840), and if the price continues to go down, he (or she) will be paying to the same trader who took a short position against you at the $1,000 BTC/USD.
In reality, margining and liquidations processes on bitcoin futures exchanges are a bit more complicated, but this example should give you the basic understanding of how to trade futures on margin.
Cross-margin and fixed margin
Two main types of margin trading modes are modes explained in this article: Cross-margin vs. fixed margin
The absence of borrowing fees and higher leverage makes trading bitcoin futures more attractive when compared to regular margin exchanges. It is essential to manage your risks properly when trading futures with high leverage. Never forget that not only your profits can be amplified, but your losses as well.