Isolated Margin Vs Cross Margin Trading

Modes of Margin

• Cross Margin: Cross margin utilizes all the available funds in your portfolio as collateral for all your trading positions. This means that if you have multiple open positions, the one in profit can cover the losses for the losing position.Thereby allowing the trader to keep their positions open for a longer time.

• Isolated Margin: This margin mode denotes that the amount of margin is specific to a single open position. Therefore, this means that the trader has an upperhand when deciding the portion of their portfolio they’d like to allocate towards that single position. Isolated margin only affects the funds you decide to allocate as collateral.

Let’s put each of these modes (Isolated margin vs cross margin trading) into deeper perspective in the section below:

Isolated Margin

Isolated margin in crypto describes a trading mode where the trader allocates a particular amount of collateral to a single position. The amount of collateral is isolated from the rest of the account’s funds. Which means that whatever happens throughout the trade, the rest of the portfolio will remain unaffected. As a risk management strategy, isolated margin allows the trader to mitigate any compromises to their trade in time. Hence, traders have the freedom to pursue other strategies in their trading accounts without worrying about the risk of liquidating their entire portfolio.

In simpler words, isolating the risks of each trade prevents losses from one position spreading to other positions. It is important for traders to carefully balance their position sizes and collateral allocation when using isolated margin. This will make sure they neither underfund nor over-leverage their positions. Other risk management practices to use alongside isolated margin trading is initiating a margin call for one to modify their margin size in case loss hits a certain threshold.

For example, Peter has a total of 10 BTC in his account balance. He longs Ethereum (ETH) using a 5:1 leverage and allocates 2 BTC as the isolated margin. This means that Peter will be trading with 10 BTC worth of ETH, i.e 8 BTC in leverage + 2 BTC his own money). If Peter closes the position after the price of Ethereum goes up, he makes additional profit. Hence adding to his initial investment of 2 BTC.

Suppose the price goes against his expectation and falls drastically, Peter can have a maximum loss of 2 BTC. The amount in his isolated margin. Nevertheless, the 8 BTC remaining in his account remains untouched even if Peter’s Ethereum position becomes liquidated. In order to protect himself from liquidation, Peter may opt to use a stop loss.

Pros and Cons of Isolated Margin

Pros

• Simple to calculate profit and loss

• Controlled risk

• High predictability which is essential for sound risk management

Cons

• Traders need to closely monitor their trades

• Limited amount of leverage

• Management cost

Cross Margin

Cross margin denotes a trading strategy where one can open a number of leveraged positions using their portfolio as collateral. Suppose you have a list of open positions and would be interested in pursuing more. On the other hand, the margin requirements are too high. Thereby making it too difficult or impossible to cover both the initial and maintenance margin. A trader may employ cross margin in this case to consolidate their list of leveraged positions. The advantage is that profits from one open position can cover losses in another position when using cross margin.

It bears mentioning that using the entire portfolio as collateral for margin debt is highly risky. However, the good thing is traders can open large positions with less money. While the strategy is risky, it does act as a protective buffer against the liquidation of individual positions. Traders should be more careful with cross margin, take time to monitor their positions closely, initiate margin calls and also place stop limit orders. However, inexperienced traders are highly advised to understand the margin policies of their trading platform before cross margining.

An example of cross margin would happen if Peter has 10 BTC in his account balance and wants to open multiple leveraged positions. However, instead of isolating the risks for each leveraged position, Peter decides to allocate his entire account balance as collateral for all of these positions. Hence, Peter longs Ethereum (ETH) using 4 BTC and a 2:1 leverage. Furthermore, Peter opens another position by shorting Solana (SOL) using 6 BTC and a 2:1 leverage. For this reason, both positions use the account balance of 10 BTC as collateral.

Let’s say Ethereum’s price performs against Peter Long’s position and goes down. On the other hand, Solana’s price goes down as expected and Peter’s short position gains profit. The profit from the short position will cover the losses on the long position. Therefore making it possible for both positions to remain open for a good amount of time.

Pros and Cons of Cross Margin

Pros

• Added flexibility when allocating margin

• One position can offset lose in another position

• Risk of liquidation is low

• Simple management, hands-off approach

Cons

• Total loss could be high if trades go unexpectedly.

• Less control on single individual trades

• Chances of overleveraging are high

• Reduced clarity on the amount of risk