Many traders regularly express some relatively big misconceptions about trading cryptocurrency futures, especially on derivatives exchanges outside the realm of traditional finance. The most common mistakes involve futures markets’ price decoupling, fees and the impact of liquidations on the derivative.
Let’s examine three simple mistakes and misconceptions that traders should avoid when trading crypto futures.
Derivative contracts differ from spot trading in pricing and trading
Currently, the total futures interest in the crypto market exceeds $25 billion and retail traders and experienced fund managers use these instruments to leverage their crypto positions.
Futures 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 differences in pricing and trading are usually missed in crypto derivative contracts. For this reason, traders should at least consider these differences when venturing into futures markets. Even well-versed derivative investors of traditional assets are prone to making mistakes, so it is important to understand the inherent peculiarities before using leverage.
Most crypto trading services do not use US dollars, even if they display USD quotes. This is a big untold secret and one of the pitfalls that derivatives traders face that creates additional risks and distortions when trading and analyzing futures markets.
The pressing issue is the lack of transparency, so clients don’t really know if the contracts are priced in stablecoin. However, this should not be a major concern as there is always the intermediary risk when using centralized exchanges.
Discount futures sometimes come with surprises
On September 9, Ether (ETH) futures that expire on December 30 are trading for $22 or 1.3% below the current price at spot exchanges such as Coinbase and Kraken. The difference emerges from the expectation of merger fork coins that may arise during the Ethereum merger. Buyers of the derivative contract will not be awarded any of the potentially free coins that Ether holders may receive.
Airdrops can also cause discounted futures prices as the holders of a derivative contract will not receive the award, but this is not the only case behind a decoupling as each exchange has its own pricing mechanism and risks. For example, Polkadot quarterly futures on Binance and OKX trade at a discount to DOT price on spot exchanges.
Note how the futures traded between May and August at a discount of 1.5% to 4%. This decline shows a lack of demand from leveraged buyers. However, considering the long-term trend and the fact that Polkadot rose 40% from July 26 to August 12, external factors are likely at play.
The futures price has decoupled from spot exchanges, so traders must adjust their targets and entry levels when using quarterly markets.
Higher fees and price decoupling should be considered
The core benefit of futures contracts is leverage, or the ability to trade amounts greater than the initial deposit (collateral or margin).
Let’s look at a scenario where an investor has deposited $100 and buys (long) $2,000 USD worth of Bitcoin (BTC) futures using 20x leverage.
Even though the trading fees on derivatives contracts are usually smaller than 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 equivalent to 4% of the initial deposit. It may not sound like much, but such a toll weighs as turnover increases.
Even if traders understand the additional costs and benefits of using a futures instrument, an unknown element tends to present itself only in volatile market conditions. A disconnection between the derivative contract and the regular loco exchanges 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 can cause drastic price action and consequent decoupling from the index price.
Although these distortions will not cause further liquidations, uninformed investors may react to price fluctuations that have only occurred in the derivative contract. To be clear, the derivatives exchanges rely on external price sources, usually from regular spot markets, to calculate the reference index price.
There is nothing wrong with these unique processes, but all traders should consider their impact before using leverage. Price decoupling, higher fees and liquidation impact should be analyzed when trading in futures markets.
The views and opinions expressed here are solely those of the writer and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should do your own research when making a decision.