What is Spot trading?
Spot trading is the most popular form of cryptocurrency trading and is the most basic form of investment. In the crypto markets, whether CEX or DEX, spot trading is simply the direct purchase or sale of a digital asset such as $BTC, $ETH, and $CHER. Exchanges facilitate the matching of buyers and sellers who exchange their assets at the spot or market price of the asset.
Since crypto exchanges operate online, spot trades can happen at any time of the day, anywhere in the world. Market participants can decide to create a market order which executes the trade (buy or sell) at the current spot (market) price plus or minus any slippage. Traders can also decide to place limit orders in which they specify the price at which the trade order will be executed. Limit orders are not subject to slippage since the target price has been stipulated by the user who is placing the trade order.
Pros and cons of Spot Trading
The risks of cryptocurrency spot trading are limited to the amount of money you invest in the market. If you invest $1,000 in a cryptocurrency or token, you run the possibility of losing that $1,000 if the value of the asset you bought goes to $0. The benefit is that you can still realize exceptional gains in your portfolio if you invest wisely.
Spot trading is useful for new investors to stay in the market for longer periods since they can just invest and let the market do what it will. An investor can put any amount into a spot trade, big or small, depending on their risk appetite and financial wherewithal.
A drawback to spot trading is that the potential gains are not as high as other trading alternatives. Margin and futures trading offer leverage, therefore, the upside (and downside) is far greater than a spot trade.
What is Margin Trading?
Margin trading is another form of cryptocurrency trading that is similar to performance speculation of an asset. Margin trading involves trading a cryptocurrency or token such as $BTC, $ETH, or $CHER, but utilizes borrowed funds to further capitalize on the future price movements of the asset.
Margin accounts allow traders and investors to borrow funds from a third party, therefore, users have the potential to gain (or lose) much higher amounts of capital through leverage. The borrowed funds are provided by other platform users who earn interest based on the market demand for margin funds.
To set up a margin trade, investors must provide some level of collateral, which is known as the margin. The collateral is a type of assurance to the lender that the funds will be repaid in full. If a trader wanted to open a margin trade at a leverage ratio of 10:1 for $10,000, the trader would need to invest $1,000 as collateral.
Pros and cons of Margin Trading
The volatility that traders experience in the cryptocurrency spot market is amplified by the leveraged positions of a margin trade.
A potential detractor to keep in mind when executing a margin trade is the hourly interest rate applied to each trade. If a margin level is reduced, more collateral must be applied to a position (or a reduction of leverage) and those margin costs can accumulate quickly. This is a margin call. The higher the ratio, the faster the margin level can plummet.
If a margin trade is trending successfully, however, high leverage ratios can help traders make incredible gains in their portfolios rather quickly. For example, traders are often able to trade from 2x-10x and higher, often making huge profits.
Using margin as a hedge investment in a portfolio could be a more responsible use of leverage. Hedging against the market using leverage may protect against major market downturns. Margin can be combined with trading tools such as stop-limit orders to protect against costly losses.
Investors who wish to trade on leverage should be fully aware of the risks associated with such strategies. This lesson provides a brief overview, but investors should do much more research into the ins and outs of leverage trading before trying it for themselves.