By Anna Churakova
By Tamta Suladze
5/5(1)

Spot vs Margin Trading: Key Aspects to Know

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Spot vs Margin Trading: Key Aspects You Need to Know

At the beginning of their journey, traders face numerous options when trading crypto, picking between spot trading and leverage trading. Comprehending the differences between these two methods is crucial for successful trading in unstable markets.

This article aims to define spot trading and margin trading and explores the contrast between spot vs margin trading. It provides information on the advantages and risks of each method, aiming to equip you with the necessary knowledge for responsible crypto trading.

Key Takeaways

  • Spot trading is a method where one asset is exchanged for another at its current price point.

  • Margin trading allows traders to use borrowed funds to increase profit.

  • Unlike the high-risk and high-profit margin strategy, spot trading is less risky and less profitable.

What is Spot Trading in Crypto?

The rule of investing is to bet less than you can afford to lose, which is easy to follow in the spot market. Spot trading is a process where one asset is traded for another at its immediate price point, which is a popular means of trading for a broad range of assets, including bonds, stocks, commodities, crypto, etc. 

This method is based on the fact that trades are settled "on the spot" within a short timeframe, unlike futures contracts or options with predetermined settlement dates.

The concept of on-the-spot trading involves three key concepts: spot price, trade date, and settlement date. The spot price is the current market price of an asset, created by buyers and sellers by posting buy or sell orders.

how spot trading works

The spot price is the immediate price point at which all assets are bought and sold, and it records the exact moment that the trade was initiated. This measure is very dynamic, as crypto asset prices tend to be volatile and can change drastically in seconds.

The trade date is the day the trade order is executed in the market, recording and initiating the transaction. The settlement date, or the spot date, is when the assets are transferred. 

The time between the trade and settlement dates can vary depending on the market type. To execute a spot trade, traders must have the full amount of funds, as the exchange or trading platform will not execute the trade if the full amount is unavailable.

How Spot Trading Works

Crypto spot trading strategies involve buying and selling digital assets at current market prices. Transactions are settled immediately, without future contractual obligations, guaranteeing instant ownership transfer. 

Spot traders aim to profit from buying at lower prices and selling at higher prices. The timeframes for this type of trading can range from minutes to weeks. Real-time crypto prices are determined by the balance of supply and demand in the spot market, influenced by market sentiment, geopolitical events, and economic trends.

Traders use their own money, limiting risk to their investment. This method is simple and suitable for novice and seasoned investors, making it a reliable investment strategy.

Let's look at the example of on-the-spot trading: With a $1,000 USD account, spot trading allows you to use your available balance to buy BTC equal to $1,000 USD.

Pros And Cons of Crypto Spot Trading

Spot trading is a straightforward and transparent method for trading crypto assets. It offers advantages such as simplicity, immediate delivery, less risk, more liquidity, and more crypto options. This strategy also offers cost-efficiency, clear regulations, anticipated profitability, and the ability to start transactions for any duration.

It allows traders to enter and exit positions at their own pace, with no contracts or expiration dates. The biggest cryptos by market cap, such as Bitcoin, Ethereum, BNB, Solana, and XRP, have high liquidity in the spot market, allowing traders to buy and sell assets without significant price slippage.

However, trading on the spot has modest gains, as traders can only use funds they already own, limiting their profit potential. Additionally, it does not involve short selling, as traders bet on future price increases.

Security risks are also a concern, as spot trading involves taking ownership of an asset and assuming all risks associated with crypto custody. Transaction fees can be a significant portion of profits for frequent traders, but it is essential to familiarise oneself with the fee structure of the service provider to avoid getting ripped off.

Spot trading remains appealing for beginners since it is more straightforward than margin or futures trading.

What is Margin Trading in Crypto?

Margin trading is a service offered by many crypto exchanges but is less accessible than spot markets due to technical reasons. Margin trading allows traders to trade not only their own funds but also borrow additional assets from brokers.

For example, with a $1,000 account, you can increase your trading power to $3,000 USD through margin trading, enabling you to buy BTC worth $3,000 USD.

how margin trading works

Margin requirements set transaction thresholds, and once these thresholds are reached, traders receive margin calls requiring them to sell their positions or add more assets to their accounts to maintain equity in volatile markets. If successful, leverage can make a trade profitable, but if not, traders may need to liquidate their assets to pay off the loan.

Margin trading involves using rented funds to increase trading positions beyond one's own capital, allowing traders to control larger market positions and increase gains and losses. However, traders may also face additional costs, such as interest and fees. Shorting opportunities and price increases are available, but there is a risk of liquidation if the market moves negatively, potentially resulting in larger losses than the initial investment.

Fast Fact

In March 2020, Bitcoin experienced a "flash crash" resulting in over $1 billion in long positions liquidating.

How Margin Trading Works

Margin trading involves traders borrowing capital to increase buying power, with borrowed funds acting as collateral. The leverage ratio determines the ratio between borrowed funds and the trader's own capital. A 5:1 leverage ratio allows a trader to open a $5,000 position with $1,000 of their own capital. However, margin trading has risks, such as margin calls requiring additional funds to maintain the minimum margin or losing the entire initial investment.

Most exchanges allow traders to trade on a margin of up to 20x leverage, or 1:20 ratio, with some going as high as 100x. This means that if Bitcoin goes up 10% to $55,000, you can double your money, resulting in a 100% profit. However, if Bitcoin goes down 10% to $45,000, you will lose twice as much, causing a 200% loss.

Margin calls occur when asset's price drops near $47,500, and if you fail to meet the margin call, your position is liquidated. The exchange automatically closes the position and sells your collateral to pay off lenders who want their principal back and interest.

Pros And Cons of Crypto Margin Trading

Leveraged trading offers higher returns by allowing users to increase their positions and short assets during market downturns and simultaneously trade multiple assets using borrowed funds, unlike spot trading, which cannot do so.

This strategy offers substantial profits, diversification, access to funds, and learning trading strategies. It allows traders to open multiple positions with minimal investment capital. However, it also has higher risks, significant losses, and extreme volatility. Even a small market price drop can cause significant losses, surpassing the trader's initial investment.

Margin trading also has the disadvantage of getting margin calls, which may require the trader to put more funds into the account and risk losing more than initially invested. Overall, margin trading is a highly profitable and highly risky investment strategy suitable for seasoned traders who know how to secure their funds and mitigate risks through due diligence.

Spot Trading vs. Margin Trading: Key Differences

Spot trading is a simple, long-term investment option that involves buying or selling digital coins at prevailing market prices. Margin trading, on the other hand, offers larger returns and increased risk. This strategy borrows funds from brokers or exchanges to trade larger positions with smaller initial investments.

Spot trading is simpler and less risky, while margin trading offers higher profits but requires careful risk management due to its inherent leverage.

Margin vs spot trading

Spot strategy is a beginner-friendly operation that maintains the number of coins despite price fluctuations. Profits are only achieved when the price rises under favourable market conditions.

Margin trading services allow large investments with small funds, maximising profits by buying long or selling short. It can be profitable even in sluggish crypto markets or price drops but requires high risks of amplified losses or forced liquidation.

Both strategies can be very profitable, depending on the business's objectives and risk tolerance.

Final Takeaways

Spot and margin trading are popular cryptocurrency investment methods, each with its own risks and benefits. Spot trading is less risky due to a lack of loan agreements or leverage ratios, but traders must be vigilant to capitalise on price fluctuations. Margin trade allows experienced traders to maximise returns with larger positions but also carries higher risks due to market fluctuations and interest rates.

Knowing spot vs margin trading differences can help beginner traders start their successful journey in the crypto market.

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