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  • Isolated margin and cross margin are two types of margin available on many cryptocurrency trading platforms.

  • Investors using isolated margin decide how much money to pledge as collateral for a particular position. However, the results of the transaction do not affect the balance remaining on the account.

  • Cross margin uses all available funds in the account as collateral for all trades. If one position turns out to be unprofitable and the other profitable, then the profit from it can be used to cover losses, delaying the liquidation of the unprofitable position.

  • The choice between isolated and cross margin depends on the trading strategy, risk tolerance and how actively the trader wants to manage their positions.

What is margin trading

We'll take a closer look at isolated and cross margin next, but first let's talk briefly about margin trading in general. With margin trading, investors borrow funds from an exchange or broker to buy or sell more assets than they could afford with their own funds. They use the assets in their account as collateral and take on debt obligations, making large bets on the movement of the asset's price in hopes of making a significant profit.

Let's say you have $5,000 and you think the price of Bitcoin will rise. You can either buy $5,000 worth of Bitcoin directly or use leverage to trade with borrowed funds. Let's say the price of Bitcoin actually increases by 20%. If you only invested your $5,000 without using leverage, you would end up with $6,000 (initial $5,000 + $1,000 profit). In this case, you would receive a 20% profit on your initial investment.

However, if you decided to use 5:1 leverage on your $5,000, you could borrow four times as much and invest $25,000 (initial $5,000 and $20,000 borrowed). In this case, if the price of Bitcoin rose 20%, your $25,000 investment would now be worth $30,000 (original $25,000 + $5,000 profit). After paying off the $20,000 loan, you would still have $10,000 left over. In this case, the profit would be 100% of the initial investment of $5,000.

Please remember that margin trading involves high risk. Let's consider the opposite scenario, where the price of Bitcoin falls by 20%. Your $5,000 investment without leverage would now be worth $4,000 (original $5,000 - $1,000 loss), a 20% loss. However, with 5:1 leverage, a $25,000 investment would be worth $20,000 (initial $25,000 - $5,000 loss). After paying off your $20,000 loan, you will be left with nothing, having lost 100% of your initial investment.

This is just a simplified example: it does not take into account trading commissions and interest paid on borrowed funds, which will reduce your profits in real trading. Remember that the market is in constant flux and you may experience losses that exceed even your initial investment.

What is Isolated Margin?

Isolated margin and cross margin are two types of margin available on many cryptocurrency trading platforms. Each margin regime has its own advantages and risks. Let's look at each of them and talk about the principles of their operation.

In isolated margin mode, the margin amount is limited to a specific position. The trader himself decides how much of his funds to allocate as collateral for a specific position. However, the results of the transaction do not affect the balance remaining on the account.

Let's say you have 10 BTC. You decide to take a leveraged long position in Ether (ETH), betting that the price of ETH will rise. You allocate 2 BTC as isolated margin for this trade with 5:1 leverage. In other words, you are effectively trading 10 BTC worth of Ether (your original 2 BTC + 8 BTC of leverage).

If the price of Ether rises and you decide to close your position, the resulting profit will be added to your initial 2 BTC margin on that trade. However, if the price drops sharply, your maximum loss will not exceed 2 BTC isolated margin. Even liquidating the position will not affect the remaining 8 BTC in the account. That is why such a margin is called “isolated”.

What is cross margin

Cross margin uses all available funds in the account as collateral for all positions. If one position turns out to be unprofitable and the other profitable, then the profit from it can be used to cover losses, delaying the liquidation of the unprofitable position.

Let's look at this with an example. Let's say your account balance is 10 BTC. You decide to take a leveraged long position on Ether (ETH) and a leveraged short position on another cryptocurrency (let's call it Z) using cross margin. For the Ether position you are trading 4 BTC with 2:1 leverage, and for Z you are trading 6 BTC with the same 2:1 leverage. The entire account balance of 10 BTC is used as collateral for both positions.

Let's say the price of Ether falls, resulting in a potential loss, but at the same time, the price of Z also falls, resulting in a profit on the short position. The profit from the Z trade can be used to cover the losses from the Ether trade, while keeping both positions open.

However, if the price of Ether falls and the price of Z rises, then both positions will be unprofitable. If these losses exceed the total account balance, then both positions will be liquidated and you will lose the entire balance of 10 BTC. There are obvious differences here from isolated margin, where only 2 BTC allocated to the transaction are exposed to potential loss.

Please keep in mind that these are just simplified examples and do not include trading commissions or other expenses. In real trading, as a rule, everything is much more complicated.

Differences between isolated and cross margin

The examples above demonstrate the similarities and differences between isolated and cross margin trading. In particular, the following differences can be distinguished:

  1. Pledge and liquidation mechanisms

Under isolated margin, only a certain portion of the funds are allocated and exposed to risk for a given trade. For example, if you trade 2 BTC on isolated margin, then only those 2 BTC are at risk of liquidation.

When using cross margin, all funds in the account serve as collateral for transactions. If one position turns out to be a loss, the system can use the entire account balance to prevent liquidation. At the same time, you risk losing your entire balance in case of losses on several transactions.

  1. Management of risks

Isolated margin provides more control over risk. You can allocate specific amounts to individual trades without putting the rest of your balance at risk. Cross margin, on the other hand, combines the risk across all open positions. It can be used to control multiple positions that can cancel each other out. However, cumulative risk also implies higher losses.

  1. Flexibility

With isolated margin, you must manually add additional funds to the appropriate position to increase the margin. In turn, cross margin automatically uses the available balance to avoid liquidation of any position. In other words, it does not require the participation of the trader to maintain the margin.

  1. Application

Isolated margin is suitable for traders who want to manage risk on individual trades, especially if they have confidence in specific positions or want to share risk. Cross margin is best suited for traders with multiple positions who would like to hedge their exposure with it, or for those who want to leverage their entire balance without having to worry about maintaining margin.

Pros and cons of isolated margin

Now let's look at the pros and cons of isolated margin.

  1. Pros of isolated margin:

Risk control: traders decide for themselves how much of their balance to allocate and how much they are willing to risk for a particular position. Only the allocated amount will be at risk, and the remaining funds in the account will remain untouched, regardless of the outcome of the transaction.

More accurate calculation of profit and loss (PnL): it is much easier to calculate profit and loss for an individual position, since the exact amount of funds tied to it is known.

Predictability: separating funds allows you to predict maximum losses in the worst case outcome and, accordingly, manage risks more effectively.

  1. Disadvantages of Isolated Margin:

Requires close monitoring: Since the position is supported by only a certain portion of the funds, the trader needs to closely monitor the trade to avoid liquidation.

Limited Leverage: If a trade becomes unprofitable and approaches liquidation, the trader will not be able to automatically use the remaining funds in the account to maintain the position. In this case, you will have to manually add funds to the isolated margin.

Management Difficulty: Managing multiple isolated margin positions can be quite challenging, especially for new traders or traders with multiple positions.

Thus, while isolated margin provides greater risk control when trading with leverage, it requires greater trader involvement and, if not managed wisely, limits potential profits.

Pros and cons of isolated margin

Now let's look at the pros and cons of cross margin.

  1. Pros of cross margin:

Flexibility in Margin Allocation: Cross margin automatically uses any available account balance to avoid liquidation of any open position, providing greater flexibility than isolated margin.

Position Compensation: Profits on one position can be used to offset losses on another position. That is, cross margin can be used in hedging strategies.

Reduced Liquidation Risk: By pooling your entire balance, the risk of premature liquidation of individual positions is reduced because a large pool of funds is able to cover margin requirements.

Convenient management of multiple transactions: it will be more convenient for a trader to manage several transactions simultaneously, since he will not have to adjust the margin for each transaction separately.

  1. Disadvantages of cross margin:

Increased risk of complete liquidation: if all positions turn out to be unprofitable and the total losses exceed the total account balance, the trader may lose all of his funds.

Less control over individual trades: Since margin is spread across all trades, it becomes more difficult to control the specific risk/reward ratio of individual trades.

Risk of Abuse of Leverage: It is quite easy to use leverage on an entire balance, and traders may be tempted to open larger positions than using isolated margin, which can result in large losses.

Difficulty in assessing the degree of risk: It is difficult to assess the overall degree of risk at first glance, especially if several positions are open with different potential for profit and loss.

Example of using isolated and cross margin

The combined use of isolated and cross margin can be an effective solution to increase profits and reduce risks when trading cryptocurrency. Let's look at this with an example.

Let's say you see a bullish trend and expect Ether (ETH) to rise in price due to upcoming updates, but want to hedge potential risks associated with market volatility. You expect the price of Ether to rise, but the price of Bitcoin (BTC) may fall.

In this case, you can allocate a certain portion of your portfolio (for example, 30%) to go long Ether using leverage and isolated margin. This will limit possible losses to this 30% in case the Ether position turns out to be unprofitable. If Ether rises in price, you will make a significant profit from this part of the portfolio.

The remaining 70% of the portfolio can be used as a cross-margin to go short Bitcoin and go long Altcoin Z, which you believe will perform well regardless of Bitcoin's movements.

This way, you use potential profits on one position to offset potential losses on another. If Bitcoin falls in price (as you would expect), then the profits from this position can offset the losses from the Z position and vice versa.

Once you open these positions, you will have to constantly monitor both strategies. If Ether starts to fall in price, you can reduce your isolation margin to limit losses. Likewise, if altcoin Z in a cross-margin strategy is not performing as expected, consider adjusting your position.

By using isolated and cross margin simultaneously, traders actively attempt to profit from their market forecasts while hedging risks. While a combination of these strategies is useful in managing risk, it does not guarantee a profit or protect against potential losses.

Conclusion

Margin trading allows you to increase profits, but at the same time exposes traders to significant risks. The choice between isolated and cross margin depends on the trading strategy, risk tolerance and how actively the trader wants to manage their positions.

In crypto trading, where volatility is often the main risk factor, it is extremely important to understand the characteristics of both types of margin. Making informed decisions coupled with careful risk management helps traders better navigate volatile cryptocurrency markets. Before starting margin trading, be sure to conduct thorough research and, if possible, consult with experts.

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