In this article, we will look at a comprehensive guide to the concept of crypto Futures Trading, and go through all the important concepts that need to be looked at before taking your first trade in the crypto Futures market!
What are Crypto Derivatives?
- A derivative in the world of finance is anything that derives value from the underlying asset it represents. In the financial trading markets, futures and options tend to be one of the most common and well-known derivative products, however, there are other kinds of derivatives products as well.Coming to crypto derivatives; which include crypto futures and crypto options. According to official definitions, a Futures contract is a legal agreement to buy or sell a particular asset, or security at a predetermined price at a specified time in the future. At the same time, “options” is another derivative product, which according to official definitions is a legal agreement that grants the buyer of the option the right but not the obligation to purchase or sell the underlying asset at a predetermined price and at a predetermined time. Some of the biggest common benefits of using derivatives products in the world of trading are because of the features they provide, like easy liquidity in markets, standardized lot sizes, and biggest of all – leverage.What are Crypto Futures?The definition of a Crypto Futures contract remains pretty much the same as crypto derivatives, but it differs in one critical aspect – the expiration date. While traditional futures contracts typically have an expiration date, crypto futures do not have an expiration date as they are perpetual futures contracts.To know more about the difference, read: Traditional futures contract vs crypto futures contractThus Crypto Futures are essentially derivatives products that are created to closely track the price of the underlying asset while providing all the benefits associated with holding a futures contract, as mentioned above. Let’s take an example.
- -Person A has a trading capital of $100.
- -Person A is bullish on BTC, and thus goes long on the BTC/USDT Futures contract with a 10x leverage.
- -Person A now holds a contract worth $1000, with a margin of $100 and a loan of $900.
How big is the Crypto Futures Market?
The crypto Futures market is something that is growing at an exponential pace, especially over the past couple of months. More and more people are willing to invest in the future of the crypto market but are not too keen on holding actual assets right out of the gate. This is where crypto perpetual Futures contracts come in to address that need.
Now, the crypto Futures market has grown so much so that Bitcoin Futures alone currently has a standing open interest of over $12 billion, according to data from Coinglass. In March 2023 alone, Bitcoin Futures saw over $1.3 trillion in trading volumes across the world, across all the major exchanges offering crypto Futures services, according to data from theblock.co! That is a huge number. However, this is still low when compared to the Bitcoin Futures trading volumes during the bull run of 2021, when in May 2021, Bitcoin Futures trading volumes hit $2.69 trillion! So there is a long way to go, almost double from current numbers.
How does Crypto Futures Trading work?
Crypto Futures trading works in a way where the exchange issues Futures contracts into the market, where there is a buyer and a seller at the same price level. Since any derivative products market is a zero-sum game, there has to be a seller for every buyer in the market, or someone willing to go short, when someone is willing to go long on the price of the underlying asset.
Thus, in the Futures market, a contract is issued when there is a seller and a buyer, and that creates the framework for crypto futures trading. The concept is pretty similar to that of traditional futures trading too, except for the perpetual contract part, where crypto futures have no expiration date.
So, what are Crypto Funding Rates?
Crypto Futures are perpetual in nature, as mentioned earlier and thus crypto Futures cannot be allowed to deviate too much from the spot prices of the underlying asset. While a traditional futures contract can deviate significantly, and the difference caused by the deviation is settled during the expiry and the contract is settled in cash.
However, crypto futures cannot be settled in cash as they are perpetual, and hence, to ensure that they do not deviate too far from spot prices, a concept called funding rates is used. So, essentially this funding rate is a system of in which periodic payments are made to either short or long traders in the futures market. It is calculated based on the difference between the contract price and the spot price of the underlying.
Managing Risk in Crypto Futures Trading
Leverage is a double-edged sword and if not managed properly or if the trader is not prepared for it, the sword can fall on the wrong side and result in what is known as ‘hard liquidation’, or in other words, a complete capital wipeout.
To ensure that this does not happen to a new trader entering the Crypto Futures market, let us take a look at some key aspects of managing risk in Crypto Futures trading.
Understanding money management
Money management in the context of trading overall basically means implementing techniques and strategies to limit your downside risk in a trade while simultaneously increasing the reward.
Utilizing take-profit and stop-loss orders
Booking profits and cutting losses are two of the most important skills a professional crypto futures trader needs to have in the market. If these two are taken care of, one can effectively be able to trade the markets while being able to manage their risk and upside potential.
Keeping emotions in check while trading crypto Futures
This is another crucial factor that can make even good traders take bad trades in the crypto Futures market. Having a proper trading strategy that includes everything from entry and exit points, risk management, and max drawdowns that a trader is willing to bear – all laid out before a trade is taken.
Building a trading plan
Building a crypto Futures trading plan is quite possibly the single most effective way of solving most of the issues that traders face while trading in the crypto Futures market.
Avoid overtrading
Overtrading can result from a string of bad trades that a trader might have suffered over a certain period of time and now wishes to get back the capital he or she has lost. While that objective isn’t wrong, the method definitely is. Overtrading in a way can lead to increased chances of taking more wrong trades in the market, thus resulting in more losses for the trader.
Understanding the risk-to-reward ratio
The risk-to-reward ratio is something that every trader should have in mind while taking a trade in the crypto Futures market. This ratio helps a person to determine if a certain amount of risk is worth the amount of potential profit that the trader stands to make from the trade. It varies from trader to trader and while there is no right or wrong, there must be a determined value for it.
FAQsIs crypto futures trading risky?
Crypto futures trading is relatively riskier than spot crypto trading as it involves the concept of leverage. But that leverage can also be properly used to amplify profit potential of investors too.
Is crypto futures profitable?
Yes, crypto futures are extremely profitable, if used properly and is the trader is aware of sound money management techniques. Thus it is imperative to learn all about futures trading before getting into it with actual hard-earned money.