Complete Guide to Margin Trading: Understanding the Basics of Margin Trading

There are many methods for investing in virtual currency, but newbies tend to think that buying virtual currency is the only way to invest. However, the market is always fluctuating, and it is important to know methods to expand profits during price rises and generate profits even in downward movement markets. This is where tools called margin buying and margin selling come in handy. This guide will explain in detail how these tools work and the associated risks.

What is margin trading (lending)?

When purchasing real estate, many people use loans. This is because they do not want to use all their funds at once. The bank is willing to lend money because there is collateral in the form of real estate. The same thinking applies in cryptocurrency trading.

In simple terms, margin trading refers to the practice where an investor puts up a portion of their own capital and borrows the rest from an exchange to purchase cryptocurrency. The cryptocurrency purchased serves as collateral.

The advantage of margin trading is that you can participate in the price fluctuations of cryptocurrencies with less capital. Since both profits and losses are magnified, it is crucial to exercise caution when using this tool.

Let me explain with a concrete example:

For example, let's assume that an investor expects the future potential of Bitcoin, and the current price is 1 million yen. However, they only have 400,000 yen on hand. Therefore, they use margin trading to purchase Bitcoin. A few days later, if the price of Bitcoin skyrockets to 1.5 million yen, the investor can obtain about 900,000 yen (150-60-interest).

The price rise rate of Bitcoin is 50%, but the return on investment for investors will be about 125%!

Even if you have 1 million yen on hand, you can use margin trading to set aside the remaining 600,000 yen for another opportunity.

In this way, margin trading is an effective tool to amplify investment effects.

Calculation Method for Interest and Costs of Margin Trading

Margin trading involves borrowing money, so it is natural to bear the interest. The interest is calculated on a daily basis, and you will pay interest for the number of days you borrowed to purchase the cryptocurrency.

The annual interest rate for exchange loans typically ranges from 4.5% to 6.65%.

For example, if you purchase Ethereum at a price of 200,000 yen using margin trading, you pay 80,000 yen yourself and borrow 120,000 yen. After 20 days, if the price of Ethereum rises to 220,000 yen and you sell it, you can receive the following amount:

100,000 yen - Loan interest 437 yen (120,000 yen × 6.65% × 20 days / 365 days)

(Fees and transaction taxes are not considered)

Interest tends to significantly compress returns over a year, so margin trading is typically a tool used not for long-term holding, but when favorable conditions are anticipated within a specific period.

Reference: Loan Interest = Loan Amount × Annual Interest Rate × Number of Days Borrowed/365

Advantages of Margin Trading

1. Expansion of investment effects

Compared to direct purchases, margin buying allows you to fully participate in the price fluctuations of cryptocurrencies with a portion of your funds, providing the opportunity to achieve significant returns with a small amount.

2. Increase in trading opportunities

By participating in the price fluctuation of cryptocurrencies with only a portion of the funds, you can manage the remaining funds more flexibly. It is possible to make additional purchases during price downward movements or diversify investments in other coins to mitigate risks.

Risks of Margin Trading

1. Forced liquidation (loss cut) risk

Margin buying involves borrowing money from the exchange to purchase cryptocurrency, with the collateral being that cryptocurrency. If the price experiences a downward movement, the exchange worries about being able to recover the money lent. Therefore, the exchange sets a "maintenance margin" and if the price falls below this maintenance margin, it requires additional "margin". If the investor does not add the margin, the exchange has the right to forcibly sell the cryptocurrency. This forced liquidation is called a loss cut.

For example:

If an investor believes in the future potential of Ethereum and uses margin trading at the point of 5 million yen, the investor pays 2 million yen and borrows 3 million yen from the exchange.

The maintenance rate at this point is 166.7% (50/30).

However, due to unexpected events such as geopolitical risks and rising interest rates, if the price of Ethereum drops to 3.8 million yen, the maintenance margin will decrease to 126.7% (38/30). At this point, the exchange will require additional collateral, and if the collateral is not added within 2 days, there is a possibility of forced liquidation.

There are two methods for adding margin:

1. Recover the maintenance margin to 130% or higher: This will prevent the exchange from executing a forced liquidation, but if the price experiences further downward movement and the maintenance margin falls below 130% again, additional margin will be required once more.

2. Recover the maintenance rate to 166.7% or higher: This will return to the initial state.

This is why terms like "margin call" and "massive liquidation" are reported in the news when the market experiences significant fluctuations.

2. Risk of income erosion due to interest

Since margin trading incurs interest, if the price remains flat for a long time, there can be a loss from interest even if there are no gains or losses in regular holdings. Therefore, margin trading is more suitable for short to medium-term investments when a price rise is expected in the near future, rather than for long-term investments.

How to Avoid Risks in Margin Trading

The risks of margin trading mainly involve loss cut and erosion of profits due to long-term interest. Therefore, after engaging in margin buying, it is necessary to closely monitor price fluctuations and always pay attention to changes in maintenance margin during price declines. Additionally, it is important to have sufficient cash reserves in case of emergencies.

Furthermore, what is important is the selection of coins and the timing of judgment. Margin trading amplifies investment effects, but it also amplifies losses as well as profits. Therefore, great care is required in the selection of coins and the timing of entry.

Moreover, in the case of stocks with small price fluctuations and main earnings coming from dividends, if the annual dividend rate is around 4-5%, it is almost offset by the interest on margin buying, making it inefficient.

Investment Strategies for Margin Trading

1. Selection of appropriate coin and target companies

In margin trading, "quick decision-making" is crucial. The optimal timing is before a company announces significant positive news, when the price has not yet entered a full upward trend. Additionally, it is advisable to choose stocks with large market value and high liquidity. When unexpected risks arise, small-cap stocks can experience severe price fluctuations and may be cut off before a sharp increase after a significant downward movement. Furthermore, situations where you want to cut losses but cannot sell should also be avoided.

2. Setting Stop Loss and Take Profit Points

Margin trading is particularly important for setting stop-loss and profit-taking in order to expand investment effectiveness. It is recommended to utilize technical analysis for observation. If it falls below the support level, immediately implement a stop-loss; if it cannot break through the resistance level, take profit. Disciplined investing is the way to consistently win in the market.

3. Cost reduction or risk diversification through diversified investment

Funds are limited, and it is not possible to accurately predict future price movements. However, it is possible to find relatively low price ranges through fundamentals and technical analysis. By utilizing margin trading, you can further break down your funds for investment.

Even if the first purchase was at the lowest price, you can still enjoy profits from subsequent rises. If the price drops further but you are confident, you can invest funds for the second and third time. If the price recovers, you can earn profits accordingly.

Additionally, since funds can be divided, it is possible to diversify investments across 2 to 3 investment opportunities at the same time. Ideally, everything would be correct, but even if one of the multiple investments is stagnant and one is on the rise, it is still possible to earn a profit.

Basics of Short Selling (Margin Trading)

As mentioned above, margin buying involves borrowing money from the exchange to purchase cryptocurrency, while margin selling involves borrowing cryptocurrency from the exchange to sell it.

The collateral for margin buying is the cryptocurrency itself, but for margin selling, it is usually necessary to deposit a certain percentage (generally 90%) of the market value of that cryptocurrency as cash collateral.

True professional investors find opportunities to generate profits not only when the market is rise but also when it is downward movement.

If a company is expected to decline, or if it is determined that the price of a specific coin is excessively high, you can use short selling (shorting) by borrowing the coin from the exchange, selling it, and then buying it back after the price has dropped to return it to the exchange, thereby making a profit from the difference.

Points to be aware of when using margin selling:

1. There is a deadline for short selling.

There are periods when short selling must be forcibly repaid (buyback) before the rights confirmation date or before the shareholder meeting. Therefore, it is necessary to pay attention to the "final repayment date for short selling."

2. There is a risk of forced settlement in margin selling as well.

Short selling profits from downward movement in price, but if the price does not fall and instead rises, losses occur. The exchange also worries that after lending virtual coins, you may not be able to buy them back, and similarly faces issues of insufficient maintenance rate if the price continues to rise. If you do not add margin, the exchange will forcibly buy back and refund according to your balance.

3. The Risks of Short Selling Traps (Squeeze)

Short selling has a deadline, and exchanges may forcibly require a buyback. Some market participants intentionally support the price of stocks with a high short selling ratio, causing further price increases after the short positions are forcibly bought back, thus securing profits. Therefore, before utilizing short selling, it is necessary to check not only the deadline but also the short selling balance of the stock to avoid the risk of a squeeze.

Summary

The essence of investing lies in understanding the target stocks and the overall market environment. It is important to combine technical analysis to predict price fluctuations and to use the appropriate tools to generate profits. Both margin buying and margin selling introduced in this article carry risks, but if used properly, they can bring significant profits to investors. Understanding the market and effectively utilizing the tools at hand are the keys to investment success.