The following is a contributed article from a content partner of Benzinga
Margin trading provides the ability to enter a trade with a position in excess of the assets in your account. Funds are borrowed “on margin” with the requirement that they be paid back at a later date with interest. If you’re trading bitcoin, for example, you can obtain the funds – usually denominated in USD/USDT – on margin from an exchange. If you’re shorting bitcoin, and the trade plays out the way you hoped, you’ll be able to repay your loan from the profit generated when BTC drops in price.
But if bitcoin moves upwards instead, your position may end up being forcibly liquidated to cover the sum you are due the broker (e.g. exchange) that provided the loan. Margin trading is therefore a delicate balancing act that must be entered into only once you’re properly educated on the risks it entails and techniques to mitigate losses. Here are four things you should know before you try shorting crypto on margin.
1. Scale in Gradually
You may be convinced that bitcoin is going to drop in price, and you may be right. The chances of you correctly calling the moment that drop occurs, though, is vanishingly small. Only once bitcoin has made a step down will that thesis have been validated, and by that point you’ll have missed out on the momentum and profit to have been made from shorting. The solution is to scale your way into the trade. Rather than putting your entire position size into the initial trade, enter with 20% of your stack, and then increase it as BTC starts to drop. That way, if BTC still has more upward momentum to expend before dropping, you won’t be in a hole. In the worst case, if BTC keeps climbing, you can close out your short in a small loss, and attempt to re-enter when there is stronger TA to support a short.
2. Set Stops
You’ve probably heard bitcoin margin traders complaining about “scam wicks” and using terms such as “short squeeze” to describe a high proportion of long or short positions, which can force traders on the other side to liquidate. These events, although short-lived, can be enough to hit your stops and blow out your trade. The solution is to set stops that will close your position in the event of sudden volatility. Derivatives exchanges provide a range of advanced order types including Stop Limit, Trailing Stop, Take Profit, and Take Profit Limit. Learn how these work and how to set them when entering a trade. It should be noted that even with stops in place, sudden market movements can result in your stops failing to be triggered. Nevertheless, setting stops will provide protection against most events that might otherwise liquidate a BTC short.
3. Watch the Open Interest
The cost of trading BTC on margin includes the ongoing interest for borrowing the asset in the first place. Open interest is charged every few hours by exchanges, and automatically deducted from your account balance. The longer you hold a position open for, the more you will pay in open interest. When most of the market is long BTC, you will pay more open interest for following the crowd. This is why if you’re shorting BTC, you want to open your position before the rest of the market has followed suit. Otherwise, your profits from shorting will be eaten up in interest.
4. Don’t Over-Leverage
Just because an exchange offers 100x leverage doesn’t mean you should use it. In fact, you almost certainly shouldn’t. The higher the leverage, the less movement there can be in the case of the underlying asset before your liquidation price is hit. With max leverage on BTC, as little as $50 in movement can be enough to see your position liquidated. Most traders don’t exceed 20x leverage and are more likely to trade with around 10x. If your thesis that bitcoin is due to drop is vindicated, there will be plenty of opportunity for profit as it moves down and your short accrues unrealized profit. Don’t get greedy by chasing oversized gains and erase your profits through over-leverage.
Shorting bitcoin on margin can be extremely profitable with practice and good timing. It’s a skill that you are unlikely to master the first few times you try it, however, so enter with caution and maintain good risk management. That way, even if the trade should move against you, you’ll get stopped out but left with funds, allowing you to return to the crypto arena and trade another day.
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