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There are different methods that are used by the crypto traders to trade cryptocurrencies. All of them have different requirements and work differently from each other. Not every method is suitable for all, but the traders choose the one feasible for them according to the market conditions. Future trading is also one of such trading methods.
However, there are some huge misconceptions that are frequently expressed by the traders about trading crypto futures. Most of them are specifically related to the exchanges derived beyond the scope of the traditional financial matters. Impact that liquidation makes on the derivative instrument and its fees and decoupling the price in the futures market are some of the very common mistakes.
Here is a detailed guide about the crypto futures, their working and the major mistakes that the traders make while trading cryptocurrency futures. Moreover, it will also explain that how to avoid those misconceptions and mistakes to prevent loss while trading.
What are Cryptocurrency Futures?
A kind of derivative trading products are known as Futures. They actually involve an agreement between two parties and are regulated trading contracts that are made when any underlying asset is sold or purchased on a certain date at a fixed price. The underlying asset in case of Bitcoin futures will be Bitcoin.
In case of volatile markets, futures provide the resistance to the traders and ensure that in future they will be able to trade any crypto asset at the fixed decided price. However, there may be a situation where the price of the asset moves totally opposite to the decided one, the owner may end up selling it at a loss and paying a higher price than the decided one.
As one is allowed to bet on the trajectory of the price of any underlying asset, the futures in crypto are similar to the futures contracts in stocks and commodities.
Working of Crypto Futures Trading
There are three main factors that facilitate in making the crypto futures trade work properly. They are mentioned as under.
- Expiration Date
The date at which, one desires to settle the futures contract is known as expiration date. This is the date where one party will be selling, and the other party has to buy at the price that has been already settled before. However, if the traders find a better opportunity, the contract can also be sold by them before the decided date.
- Units per Contract
It varies for every platform. This decides the worth of the contract in regard of its underlying asset.
In order to increase the trading size, the users are allowed by the exchanges to borrow capital. The traders usually make the futures bet to increase their potential trades. The size of leverage offered varies for each platform.
Types of Cryptocurrency Futures Contracts
There are a number of types that can be chosen by the traders to carry out the trade. However, the traders should be aware of the fact that all the trading platforms do not provide all types of Futures trading. Some of the kinds of crypto futures contracts is mentioned below. The two parties can settle their futures contract in either of the given ways.
- Standard Futures Contracts
These future contract usually own all kinds of features that a traditional crypto asset should have. These features may include settlement and expiry of the contract. The buyer and the seller exchange cash mostly US Dollars once the matter is settled between both the parties. The two parties settle the contract by every three months and the experts consider it an ideal situation.
- Futures With Physical Delivery
The buyer receives Bitcoin by purchasing them upon the settlement of the matter between the two parties. These kinds of Futures contracts also have the expiry dates. The futures contracts that operate on physical delivery mechanism help in the transfer of Bitcoin to the ones that have bought them at the expense of cryptocurrency once the expiry date arrives.
- Perpetual Contracts
This is another type of futures contracts that is very popular among the developers. It was quickly adopted by a multiple of crypto exchanges as it does not depend on the expiry date if the contract. Funding is the main process that helps in keeping the futures contracts closer to the spot price as it could be.
At certain hours, the traders pay each other when the positions open. The positions among the two parties that who will ne paying and who will get paid is decided by the difference between the spot price and the perpetual price of the contract. In case the funding is negative, the traders with short positions are compelled to pay long. On the other hand, in case of positive funding, the traders are compelled to pay short who initially had long positions in the market.
Though the perpetual contracts are becoming popular, there are still some factors that need to be improved.
Three Major Mistakes That Should be Avoided While Futures Trading
A number of traders while dealing with crypto futures fall for these three major mistakes.
- Difference of Pricing and Trading Between Derivatives Contracts and Spot Trading
In the crypto market, the aggregate of the open interest in futures has surpassed about 25 billion dollars. In order to leverage their cryptocurrencies, the experienced fund managers and retail traders utilize these instruments.
Moreover, to increase the exposure and to decrease the risk, future derivatives and its other derivatives are mostly used. Though it is interpreted commonly about the futures that they are used for degenerate gambling, however this is not the case.
Using the crypto derivatives contracts, one usually misses the difference between pricing and trading. Therefore, while venturing in the futures market, it is important for the traders to keep an eye on the differences. It is a possibility that mistakes can be made even by the professional and expert traders therefore, before leveraging any product, it is essential for the traders to carry out a thorough research and understand the complications involved.
Though most of the times USD quotes are displayed by most of the trading services, they do not use the United States Dollars usually. Nobody speaks about this, and it is usually kept as a secret that ends in creating a difficulty for the traders. Most of the traders dealing with derivatives face the problems that also cause a number of risks and anomalies when they analyze and trade in the futures market.
Way Forward: The lack of transparency is the main issue that creates a confusion among the clients. They have no idea that if their contracts have been priced using the stablecoins or not. However, while using the centralized exchanges there is always a risk involved therefore one should not be concerned about such issues.
- Surprises Attached with Discounted Futures
Using the spot exchanges such as Kraken and Coinbase, Ether Futures were traded in September almost 1,3% lesser than their original price. The prices differ because during the Ethereum Merge, it is also expected that Merge fork coins will get an uprise. The free coins that will be received by the Ether holders, the ones who buy the derivatives coins are not considered eligible for them.
As the rewards will not be given to the holders of the derivatives contracts, the prices of the futures can also be decreased because of airdrops. However, as there are risks and pricing mechanisms involved with every exchange, the above-mentioned reason is not the only one for decoupling process.
As compared to the Polkadot price on the spot exchanges, OKX carries out the trade at a discounted price. Moreover, the futures are made on Binance quarterly. In between the month of May and August, the futures contract traded at a discount between 1.5% to 4%. A decrease in demand on the part of leverage buyers is demonstrated by this backwardation. The external factors are also playing the role when the long-lasting impacts of Polkadot are considered.
Way Forward: Using the spot exchanges, the contract prices of futures have decoupled. Therefore, it is important for the traders that while dealing with the quarterly prices, they should adjust their entry levels and targets accordingly.
- Considering Higher Fees and Price Decoupling
Leverage is one of the main benefits of using the future contracts. It provides them the opportunity to carry out trade in the amount a lot more than their initial profits. This can be understood using the example where a buyer uses leverage about 20 times when he gets about 2000 dollars in worth of Bitcoin when he initially deposited about 100 dollars.
As compared to the spot makers, the derivatives contracts have usually lower trading fee. For every trade of about 2000 dollars trade, there is a hypothetical fee of about 0.05%. Therefore, if one enters a position or exits it, the cost of about 4 dollars have to paid ever time. This is about the 4% of the initial deposit. One might think of it as a less amount, but as soon as the turnover increases, the toll also increases with it.
An unknown element can only represent itself in the volatile market even though if the benefits and additional costs integrated with the futures instruments are understood by the traders. The main reason of decoupling is the liquidations between the regular spot and the derivatives contract.
In case the trader faces a loss that and the collateral owned by the trader is not sufficient enough to overcome the loss, the built-in mechanism owned by the derivatives exchange helps in closing the position. A consequent decoupling from the index price and a drastic price action is caused by the liquidation mechanism.
Though no new liquidations will be triggered by the distortions in the mechanism, however, the changes and price fluctuations that only occurred in the derivatives contract might face a reaction from the investors who were not informed about it before. One should be aware of the fact that in order to calculate the reference price index, the derivatives exchange usually depend on the external pricing sources that are usually derived from regular spot markets.
Way Forward: All these processes are unique and there is no problem in dealing with them however it is important for the traders to study their impacts and effects before leveraging any product. Whenever one decides to trade in the futures market, he should consider the factors like liquidation impact, higher fees and decoupling of the price beforehand.
Benefits of Futures Trading
The provision of regulated exposure to the cryptocurrencies is one of the main advantage of trading Bitcoin Futures. It provides recourse and confidence to the institutional investors that is composed of a number of traders in the contracts.
- Simple and Feasible
Bitcoins can easily be invested by using Bitcoin futures. For the storage and security purposes while carrying out the trade it is not necessary that the user has to create a wallet. The risk of the physical ownership of any volatile asset is also eliminated because of these contracts that are easily settled by cash.
- Low Commission Costs
When a position is closed, then the commission is charged that is usually very low. One can count it as about only 0.5% of the total amount that the two parties have decided over the contract. However, it also depends on the services that one will get from the broker that is acting as the mediator between the two parties.
- More Efficient and Fair
Futures markets are more efficient, and the investors can gain a fair shake in the market. Such market aggregates are traded by the future markets that are normally not lent by the insider trading. One cannot easily trade on the information inside the futures market.
- Help in Fast earning
Futures help in earning money easily if the investor is efficient and trades logically. This is because the traders have about 10 times as much exposure as the traders that are selling stocks. Moreover, as compared to cash the prices of the futures market move fast.
- Easier Short Selling
By selling the Futures contract, the stocks in the market can gain a certain exposure. It is considered completely legal and is applicable to all kinds of futures contracts.
Risks Involved in Futures Trading
Trading futures could be attractive however there are some significant risks also involved with trading futures. Some of them are mentioned below.
First of all, the most important risk that comes with trading futures is leverage. An experienced trader is aware of the fact that if leveraging any product provides benefit and increases the chances of profit, at the same time, it also increases the chances of loss equally. Some experts are of the view that it is more important issue to tackle than the volatility of the crypto market even.
- Initial Margin
Before borrowing money from an exchange as a leverage for trading futures, the trader has to keep a certain amount of investment as an insurance initially. This is because in case he faces a loss he could recover it using that amount. However, this amount is held by the exchange, and it keeps it in its custody. That payment can only be accessed by the owner when he returns the amount that is initially borrowed after winning the trade.
- Irreversible Loss
The position of the trader will automatically be liquidated, and the trade will be closed as soon as the investor loses a trade. This causes the trader to lose the initial margin that he had kept as an insurance at the start. This loss can not be recovered at any cost by the investor. This is the reason that for the beginners, leveraging their assets is not advised usually.
Should the Crypto Futures be Traded?
One can earn the maximum rewards from crypto futures trading in the same way as from any other crypto trading process. However, to gain more profit and to eliminate the chances of losses from trading, it is important to invest time and to train oneself properly. Otherwise, one can end up losing all his assets before even starting the trade.
One needs to train himself properly and understand the technicalities involved in the market before completely engaging with it if he is new to crypto and is interested in trading crypto. Have a thorough research about different factors having an impact over the cryptocurrency that one wants to trade and the market in general.
This will help the traders in gaining maximum gain out of the initial investment and take sound and informed decisions while trading.
In case one is enthusiastic about the futures trading in the crypto market, it is necessary for him to be patient and invest logically keeping in mind the ups and downs of the crypto market. He should analyze all the factors that affect the futures trading and then invest accordingly in the market. This can help in gaining the profit and refrain one from making mistakes that could then lead to some major loss.