Many traders frequently express relatively major misconceptions about trading cryptocurrency futures, especially on derivatives exchanges outside of the realm of traditional finance. The most common errors relate to the decoupling of futures market prices, fees and the impact of liquidations on the derivative instrument.
Let’s explore three simple mistakes and misconceptions traders should avoid when trading crypto futures.
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Derivative contracts differ from spot trading in terms of pricing and trading
Currently, the global open interest in futures contracts in the crypto market exceeds $25 billion and experienced retail traders and money managers are using these instruments to leverage their crypto positions.
Futures contracts and other derivatives are often used to reduce risk or increase exposure and are not really meant to be used for degenerate gambling, despite this common interpretation.
Some price and trading differences are commonly missed in crypto derivatives contracts. For this reason, traders should at least consider these differences when venturing into the futures markets. Even knowledgeable investors in traditional asset derivatives are susceptible to mistakes, so it’s important to understand the quirks before using leverage.
Most crypto trading services do not use US dollars, even if they show quotes in USD. This is an indescribable big secret and one of the pitfalls faced by derivatives traders that leads to additional risks and distortions when trading and analyzing futures markets.
The pressing problem is the lack of transparency, so customers are unsure whether contracts are priced in stablecoins. However, this should not be a major concern, given that there is always intermediate risk when using centralized exchanges.
Discounted futures sometimes hold surprises
On September 9, Ether (ETH) futures contracts that expire on December 30 are trading at $22 or 1.3% below the current price on spot exchanges like Coinbase and Kraken. The difference emerges from the expectation of fusion fork coins that may arise during the Ethereum merger. Buyers of the derivatives contract will not receive any of the potentially free coins that Ether holders can receive.
Airdrops can also lead to reduced futures prices since holders of a derivative contract will not receive the price, but this is not the only case behind a decoupling since each exchange has its own pricing mechanism and risks. . For example, quarterly Polkadot futures on Binance and OKX are trading below the DOT price on spot exchanges.
Notice how the futures contract traded at a 1.5% to 4% discount between May and August. This backwardness demonstrates a lack of demand from leveraged buyers. However, given the lasting trend and the fact that Polkadot rebounded 40% from July 26 to August 12, external factors are likely at play.
The price of the futures contract has decoupled from spot exchanges, so traders need to adjust their targets and entry levels each time they use the quarterly markets.
Higher fees and price decoupling should be considered
The main advantage of futures contracts is leverage, or the ability to trade amounts greater than the initial deposit (collateral or margin).
Consider a scenario where an investor has deposited $100 and buys (long) US$2,000 worth of Bitcoin (BTC) futures contracts using 20x leverage.
Even though trading fees on derivative contracts are generally lower than on spot markers, a hypothetical fee of 0.05% applies to the $2,000 trade. Therefore, entering and exiting the position once will cost $4, which is equal to 4% of the initial deposit. It may not seem like much, but such a toll weighs as turnover increases.
Even though traders understand the additional costs and benefits of using a futures instrument, an unknown element tends to only present itself in volatile market conditions. A decoupling between the derivative contract and regular spot trading is usually caused by liquidations.
When a trader’s collateral becomes insufficient to cover the risk, the derivatives exchange has a built-in mechanism that closes the position. This liquidation mechanism could lead to drastic price action and a consequent decoupling of the index price.
Although these distortions do not trigger new liquidations, uninformed investors could react to price swings that only occurred in the derivatives contract. To be clear, derivatives exchanges rely on external price sources, usually regular spot markets, to calculate the benchmark price.
There is nothing wrong with these unique processes, but all traders should consider their impact before using leverage. Price decoupling, higher fees and the impact of liquidation should be considered when trading futures markets.
The views and opinions expressed herein are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.