Cross margin and isolated margin in crypto trading, explained

What is cross margin in crypto trading?

Cross-margin trading is a risk management tactic in cryptocurrency trading whereby traders utilize the whole balance of their accounts as collateral for their open positions.

Using account balance as collateral implies that the entire amount of the account is at risk in order to cover future trading losses. Cross margining makes higher leverage possible, allowing traders to open larger positions with less money. It bears more risk but prevents individual position liquidation by acting as a buffer with the account balance.

To reduce risk, margin calls may be made, and traders must carefully monitor their positions and put stop-loss orders in place to limit losses. For seasoned traders, cross margining is a potent strategy, but it should be utilized with caution and a solid risk management plan. Novices and those with little prior trading experience should completely understand the platform’s margin rules and policies.

How cross margin is used in crypto trading

To understand how cross-margin trading works, let’s consider a scenario where Bob, a trader, chooses cross margining as his risk management strategy with $10,000 in his account. This trading strategy involves using the whole balance of his account as security for open trades.

Bob chooses to go long when Bitcoin (BTC) is trading at $40,000 per BTC and buys 2 BTC using 10x leverage, giving him control over a 20 BTC position. However, it is important to note that he is using the first $10,000 as collateral.

Fortunately, the price of Bitcoin soars to $45,000 per BTC, making his 2 BTC worth $90,000. Bob chooses to lock in his profits and sell his two BTC at this higher price. As a result, he ends up with $100,000 in his account — $10,000 at the start plus the $90,000 profit.

However, if the price of Bitcoin had dropped significantly, let’s say to $35,000 per BTC, Bob’s 2 BTC position would now be worth $70,000. Sadly, in this instance, Bob’s account balance would not be enough to offset the losses brought on by the declining price.

The position would have been secured with his initial $10,000 in collateral, but he would now have an unrealized loss of $30,000 (the difference between the purchase price of $40,000 and the current value of $35,000 per BTC). Bob would be in a precarious situation with no more money in his account.

In many cryptocurrency trading platforms, a margin call could happen if the losses are greater than the available collateral. A margin call is a request made by the exchange or broker that the trader deposits more money to offset losses or shrink the size of their position. To prevent future losses, the exchange might automatically close a portion of Bob’s position if he couldn’t fulfill the margin call requirements.

What is an isolated margin in crypto trading?

In the world of cryptocurrencies, isolated margin trading is a risk management strategy where traders allocate a certain amount of collateral to each individual position they open.

In addition to protecting other positions and the overall account balance from potential losses in any one trade, this method enables exact control over the risk involved with each trade. A set amount of collateral backs each position, and only the collateral assigned to that particular position is at risk if a trade goes against the trader.

By isolating the risk, losses from one position are prevented from spreading to other holdings or the account’s total balance. Leverage is still allowed with isolated margin, but traders can fine-tune the leverage for each position, enabling a more personalized risk management strategy.

In isolated margin trading, it is essential to carefully manage position sizes and collateral allocation to avoid overleveraging or underfunding positions and protect the trader’s entire portfolio. Additionally, certain exchanges may put margin calls in place that require traders to increase their collateral or modify their position size if losses reach a specified threshold.

How isolated margin is used in crypto trading

To understand how isolated margin works in crypto trading, let’s say Alice chooses to engage in isolated margin trading and maintains a trading account with $10,000. She wishes to trade Ether (ETH) and BTC separately, each with a distinct and isolated margin.

She sets aside $2,000 as a reserve in her account and allocates $5,000 as collateral for her BTC trade and $3,000 for her ETH trade. This strategy separates her BTC and ETH positions from one another, limiting any potential losses to the assigned collateral for each trade.

If the price of Bitcoin falls while her BTC position is open, for example, her losses are limited to the $5,000 set up as collateral for that trade. Losses in one trade won’t have an impact on her other positions because she hasn’t touched the $3,000 set aside for the ETH position. This fine-grained control over risk enables Alice to handle each trade on her own.

Even if the BTC position has losses that are greater than the $5,000 in collateral, a margin call wouldn’t be issued and her ETH trade wouldn’t be impacted. An isolated margin allows Alice to proactively manage risks and protect her entire portfolio, thanks to the specific collateral allocation for each position. However, careful risk management and position size monitoring are essential for ensuring a balanced and secure trading approach.

Related: Day trading vs. long-term cryptocurrency hodling: Benefits and drawbacks

Pros and cons of cross margin

Cross-margin trading simplifies risk management but poses the risk of substantial losses by using the entire account balance as collateral.

On the positive side, cross-margining makes risk management straightforward by using the full account amount as collateral and may help restrict individual holdings from being prematurely liquidated.

It also provides the opportunity for higher profits due to greater leverage. However, every trade involving the entire account balance could result in huge losses or account liquidation. Furthermore, the lack of granularity in risk control and the possibility of margin calls can make it challenging to implement precise risk management strategies and diversify effectively.

In addition, because traders could be unwilling to invest their whole account balance in several positions, cross-margining may hinder diversification and expose them to concentrated risk. For instance, if a trader invests their whole account balance in a single, extremely volatile cryptocurrency and that particular asset experiences a significant price drop, the trader’s entire account balance could be wiped out, illustrating the risk of not diversifying across different assets or positions.

Pros and cons of isolated margin

Isolated margin trading provides for precise risk control and diversification, but it also necessitates careful monitoring of trading positions and may require more funds than cross-margin trading.

Isolated margin trading allows traders to precisely manage risk by enabling them to assign particular collateral amounts to individual transactions. This granularity lowers the possibility that one trade can negatively impact others by ensuring that losses are restricted to the collateral supplied to each trade.

Additionally, isolated margin trading encourages efficient diversification by allowing traders to distribute their assets across various positions and assets, reducing the danger of concentration.

The isolated margin trading strategy does have some complexities, though, particularly for traders with numerous open transactions. Managing collateral for multiple positions can be difficult and may require constant attention. Additionally, compared to cross-margin trading, where the total account amount acts as collateral for all positions, allocating collateral individually may require more money.

Insufficient collateral for any particular position may lead to margin calls or partial position closures, necessitating constant monitoring and precise risk management; thus, traders must remain watchful. Isolated margin provides customized risk management, but meticulous position handling and monitoring are necessary.

Cross margin vs. isolated margin: Key differences

In contrast to isolated margin, which offers greater control and diversification but necessitates more active management, cross-margin trading simplifies risk management while increasing overall risk.

Cross-margin trading offers streamlined risk management but may expose the entire account to significant losses because it uses the whole account balance as collateral for all positions. Isolated margin, on the other hand, allows traders to assign particular amounts of collateral to individual positions, giving them precise risk control and facilitating diversification.

Cross margining can cause holdings to be prematurely liquidated in volatile markets, whereas isolated margin reduces the possibility of one position’s losses affecting others. Additionally, isolated margin offers more flexible alternatives for leverage, albeit with increased complexity in managing multiple positions and collateral allocations.

Here’s a quick summary of the differences between cross and isolated margins:

The decision between cross and isolated margin ultimately depends upon one’s level of risk tolerance, trading approach and diversification objectives.