The beginner's guide to cross and isolated margins and how to prevent losses on cross margin trades! Read more!
These days, many exchanges offer leverage trading features in one way or another. A major difference lies in the type of margins used by exchanges - the common ones are cross and isolated margins.
Before we get into the different types of margins, let’s briefly look back on what margin is. Let’s say Jack has $1000 of your own money as collateral for a leveraged position, this is what we refer to as margin. The position size can be larger than that, using leverage.
You may also check out “What Is Leverage in Crypto Trading?”
The image below shows the order screen on Binance Futures. On the top left, you see cross and isolated margin options. Let’s get into what these two mean.
By the way, if you are not sure how to trade futures on Binance, you may check out our comprehensive guide on the subject!
What Is Cross Margin?
The most commonly-used margin mode across exchanges is called cross margin. In this mode, your entire account balance is used to margin all open positions. The good part about cross margin is that P&L from one position can be used to support a position that is close to liquidation. Depending on the platform, this works with unrealized P&L too.
While this type of margin is very straightforward and easy to use, it does not come without risk. Traders, who use cross margin, risk losing their entire account in case of liquidation. In the example used earlier, Jack would lose the entirety of his $1000. The only way to prevent liquidation is to add more money to the account.
What Is Isolated Margin?
In the Isolated Margin mode, you allocate margin specifically to a position or trading pair. As you can see in the screenshot below, the platform asks you to transfer funds into the isolated margin before you can trade.
This mode of margining allows you to manage your risk on a specific pair or position by choosing how much margin is allocated to it. This is quite helpful in worst-case scenarios as only the funds allocated to the position can be liquidated.
Let’s apply this to the example of Jack!. If Jack uses isolated margin, he can choose how much of that $1000 he wants to allocate to a certain position. For example, he longs $1,250 worth of BTC but is only ready to lose $125 in case of liquidation. Jack, therefore, sets the isolated margin to 125 USD, which is then the maximum amount he would lose if the position gets liquidated.
If the position goes underwater and gets close to being liquidated, Jack can still decide to add margin to the position. I personally do not recommend adding to a losing position, but rather sticking to the plan you had from the start.
Which One Is Better?
I don’t think there is a black and white answer to this. A major factor in deciding which one is for you lies in how you manage your risk. After all, a stop loss (whether on a cross margin or isolated margin position) still ensures the losses of a position are capped to a preset amount.
To put it simply, with proper risk management, liquidation can be avoided altogether, which means cross margin isn’t as risky as it sounds. Instead, it becomes a highly useful tool that allows you to use P&L from the winning position to rescue a losing position. Pretty good, right?
If you like to partially hedge positions, or take pair trades (for example, shorting Bitcoin while longing AVAX), cross margin might therefore be more attractive. If you take single trades, you could be more inclined to use isolated margin. In my opinion, it’s really a question of preference, rather than superiority.
Closing Statements
Now that you know the differences between cross and isolated margin, you can decide which one is best for you. Please do not forget the importance of managing risk, especially when trading with leverage. As long as you do this, margin trading (both cross and isolated) is a great tool in the toolbox.
As usual, please remember this article is based on my own experiences in trading, and it does not constitute financial advice. Do your research, try new things out and let’s continue to make some money!
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