What Does Trading Crypto Futures Mean?
Crypto futures trading is like a fascinating adventure where you try to predict if the value of digital coins will go up or down. You don't actually own these coins, but you make smart guesses about their prices. Imagine you're at an auction where people are constantly buying and selling the same coins over and over and you're trying to predict which direction the prices of the coins are going in order to profit from it.
Buying or “Going Long”
If you think the price of the coins will go up, you can "buy" or “go long” on it. The term “going long” is synonymous with “buy” and is typically used for taking a position where you think a coin's value will go up.
Selling or “Going Short”
Alternatively you can "sell" or “short” the asset when you think it will go down. The term “short” or “shorting” means that you are taking a position believing that the value of the underlying asset is going to go down
What is Margin and How is it Used?
Here's how margin works with examples:
1. Initial Margin:
An investor has $1,000 in their trading account. They want to buy 1,000 coins priced at $25 per coin, which would cost $25,000. The investor can use margin to borrow $24,000 from their broker or exchange to complete the purchase. The investor’s $1,000 represents the initial margin requirement and is leveraged by 25x to give them $25k in buying power. The $24k that is borrowed on margin will be subject to interest that is paid to the broker or exchange until the borrowed funds are repaid..
2. Maintenance Margin:
If after purchasing the coins, the price of them drops to $18 per share. To protect the broker from potential losses, a maintenance margin requirement is set, typically lower
than the initial margin. So for example if the maintenance margin is set at 80%, the investor's account should hold at least 80% of the total borrowed amount, or $19,200 (24,000*0.80 = 19,200), to avoid a margin call.
3. Margin Call:
If the account balance falls below the maintenance margin, the broker may issue a margin call. In our example, if the account balance drops to $18,000,
the investor must deposit more funds to meet the maintenance margin requirement. The investor would
need to deposit an additional $1,200 to meet the 80% maintenance margin requirement. Failure to meet the margin call can lead to the broker selling off some of the investor's assets to cover the debt. So in this scenario, if the investor was unable to deposit an additional $1200, the broker or exchange would automatically sell some of the coins held by the investor at a loss in order to meet the margin call.
4. Margin Trading and Leverage:
Using margin can amplify both gains and losses. In the example, if the coin price rises to $30, the investor sells the coins for $30,000. After repaying the $24,000 borrowed (plus interest), the investor is left with $6,000, resulting in a $5,000 profit. However, if the stock price had dropped, the losses would have been magnified as well.
Margin trading is a powerful tool that allows traders to control larger positions than their own capital would allow. It can be lucrative but also risky, as it involves borrowing money and potential losses exceeding the initial investment. It's important for traders to understand margin requirements, manage risk, and have a clear strategy when engaging in margin trading.