Cross and Isolated Margin: How They Work, Their Differences, What They Are Used for

What is cross margin?  

One of the key trader’s tasks in margin trading is to effectively manage resources and risks.  

In simple words, a cross margin is the use of all funds on an account balance as collateral. Since it can be applied to several trades at once, it is also called a cross margin.  

Principle of Cross-Margin Operation

The main principle is that a profitable deal can cover losses from a losing position. Let’s take a closer look at what cross margin is and how it is used in trading.

Example:  

Imagine that you have 5 ETH in your account. You open a long position on cryptocurrency A and a short position on token B, using leverage and cross margin (the entire balance). On the long position, you trade with 2 ETH, and on the short position, you trade with 3 ETH, using 2:1 leverage.

Let’s say the prices of tokens A and B are falling. The long position is at a loss, and the short position is at a profit. In this case, you can spend the income from the transaction with cryptocurrency B to compensate for the losses on the other position and avoid closing.

If token A goes down in price and B goes up in value, both trades will fail. If the total losses exceed the margin, both the long position and the short position will be prematurely closed. You will lose all the money in your account.  

Pros and cons of cross margin

Using one collateral for all trades gives a trader some advantages:  

• Flexible allocation of collateral.
• Compensation of losses.
• Possibility to avoid premature closing of trades.
• Simultaneous management of positions.

However, cross-margin also has disadvantages:  

• High probability of capital loss (if forecasts do not come true);  
• Complicated control of the ratio of potential profit to risk;  
• Leverage abuse.

What is an isolated margin?  

In exchange trading, an isolated margin is an opportunity to set separate collateral for each transaction. In this case, the collateral is not the entire amount on the account but only its part. Both cross and isolated margin are actively used in trading.  

The principle of isolated margin  

The main principle is that the investor determines the amount of collateral corresponding to a certain position. The result of the transaction does not affect the amount remaining in the account. To better understand what an isolated margin is, let’s consider a specific case.

Example:  

Imagine you have 10 ETH on your balance. You bet on the growth of cryptocurrency A and open a long position with a leverage of 5:1 and a margin of 2 ETH, which, in reality, allows you to trade 10 ETH.

If your prediction comes true, you can close the trade and lock in your earnings, which will be added to the margin. If cryptocurrency A goes down in price, you will lose no more than 2 ETH of isolated collateral. The remaining amount in your account will not be affected.  

Pros and cons of isolated margin

Investors use this type of margin in crypto trading because it provides:

• Independent risk management.
• Quick calculation of profits and losses.
• The possibility to anticipate maximum losses at the worst result. 

Experts list the following disadvantages of isolated margin:

• The need to constantly monitor the position to prevent its closure;  
• Independent replenishment of margin; 
• Complexity of simultaneous management of transactions.  

What is the difference between an isolated and cross margin?  

Each type of collateral has its features and a certain risk level. Let’s find out what the difference between a cross margin and an isolated margin is:  

• Formation of collateral. With a cross margin, the entire balance is involved, with isolated — only the amount determined by the trader.  
• Liquidation. A cross margin jeopardizes the entire capital, while an isolated margin jeopardizes only a certain amount.  
• Flexibility. The trader adds funds to the isolated margin, while with cross margin, the balance is distributed automatically.  

In what situations an isolated and cross margin is used? If a trader is confident in individual positions and wants to limit risks, they choose an isolated margin. A cross margin is an optimal option for investors who wish to apply leverage to their entire balance and hedge the risks of several trades.  

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