Key Mistakes to Avoid When Trading Crypto Futures

Many traders regularly express some relatively serious misconceptions about crypto futures trading, especially on derivatives exchanges outside of the traditional financial sector. The most common mistakes relate to price decomposition of the futures market, fees, and the impact of liquidation on derivatives.

Let’s take a look at 3 simple mistakes that traders should avoid when trading futures.

Difference between derivatives and spot trading: Valuation and trading

Currently, the open interest (OI) value of futures contracts in the crypto market exceeds the $25 billion mark, and both retail traders and experienced fund managers use the tool to leverage their crypto positions.

Futures and other derivatives are often used to reduce risk or increase exposure, but that is not synonymous with corrupt gambling, although often interpreted this way.

Some price and transaction differences are often overlooked in derivatives contracts. Therefore, traders should at least consider the differences when venturing into the futures market. Even well-versed derivatives investors in traditional assets are prone to mistakes, so it’s important to understand the peculiarities that exist before using leverage.

Most crypto trading services do not use US dollars, even if they display USD quotes. This is a big unknown secret and one of the pitfalls that derivatives traders face, adding to the risk and imprecision when trading or analyzing the futures market.

The pressing issue is the lack of transparency, so customers don’t really know if the contracts are priced in stablecoins. However, this is not the biggest concern, as there is always an intermediary risk when using centralized exchanges.

Discount futures sometimes come with surprises

On September 9, ETH futures expiring on December 30 were trading for $22 or 1.3% below the price at spot exchanges like Coinbase and Kraken. The difference is due to the expectation of the coin fork during the Ethereum Merge process. Derivatives contract buyers will not be given any potential free coins that ETH holders may receive.

Airdrops can also cause futures prices to drop as derivatives holders will not receive rewards, but that is not the only case of price splits as each exchange has its own pricing and risk mechanisms. private. For example, quarterly DOT futures on Binance and OKX are trading below the DOT price on spot exchanges.

Quarterly DOT Futures Spread on Binance
Quarterly DOT Futures Spread on Binance | Source: TradingView

Notice how the futures contract trades at a discount of 1.5% to 4% between May and August. Such a put-off indicates a lack of demand from buyers who use them. use leverage. However, considering the protracted trend and the fact that DOT increased by 40% from July 26 to August 12, perhaps external factors are the main cause.

Futures prices are slowly decoupling from spot exchanges, so traders must adjust their targets and participation levels whenever using the market quarterly.

Higher fees and price separation

The core benefit of futures is leverage, or in other words the ability to trade larger amounts than the initial deposit (margin or margin).

For example, an investor deposits $100 and buys (Long) $2,000 worth of BTC futures using 20x leverage.

While trading fees on derivatives contracts are typically less than spot fees, a hypothetical 0.05% fee will apply for a $2,000 trade. Therefore, a one-time entry and exit of a position will cost $4, which is equivalent to 4% of the initial deposit. It might not sound like much, but such a fee would be a burden if revenue were to grow.

Even if traders understand the costs and benefits of using a futures instrument, there is another factor that cannot be determined that often comes into play only in volatile market conditions. The split between derivatives contracts and regular spot exchanges is also due to liquidation.

When a trader’s collateral is not enough to cover the risk, the derivatives exchange has a built-in mechanism to close the position. This liquidation mechanism triggers drastic price action and consequent decoupling from the index price.

While these deviations will not cause further liquidation, the uninformed investor can react to price movements that occur only in derivatives contracts. To be clear, derivatives exchanges rely on an outside source of pricing, usually from conventional spot markets, to calculate the index price.

There is nothing wrong with these unconventional processes, but all traders should consider their impact before using leverage. It is necessary to assess the situation of price splits, higher fees and liquidation effects when trading in the futures market.

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