3 top mistakes to avoid when trading cryptocurrency futures markets

Many traders often express some relatively large misconceptions about trading cryptocurrency futures, particularly about trading derivatives outside the realm of traditional finance. The most common errors relate to the decoupling of futures market prices, commissions and the impact of settlements on the derivative instrument.

Let’s look at three simple mistakes and misconceptions that traders should avoid when trading cryptocurrency futures.

Derivative contracts differ from spot trading in price and trading

Currently, the aggregate interest of open futures in the cryptocurrency market exceeds $ 25 billion and experienced retail traders and fund managers are using these tools to leverage their cryptocurrency 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 differences in pricing and trading are usually lost in crypto derivative contracts. For this reason, traders should at least consider these differences when venturing into the futures markets. Investors who are experienced in traditional asset derivatives are also prone to making mistakes, so it is important to understand the peculiarities that exist before using leverage.

Most cryptocurrency trading services do not use US dollars, even though they show USD quotes. This is a big untold secret and one of the pitfalls faced by derivatives traders that causes additional risk and distortion when trading and analyzing futures markets.

The pressing issue is a lack of transparency, so customers don’t really know if contracts are priced in stablecoins. However, this shouldn’t be a big deal considering there is always intermediary risk when using centralized exchanges.

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Discounted futures sometimes have surprises

On September 9, Ether (ETH) futures expiring on December 30 are trading at $ 22 or 1.3% lower than the current price on spot exchanges such as Coinbase and Kraken. The difference emerges from the expectation of coin merge forks that could arise during the Ethereum merger. Buyers of the derivatives contract will not receive any of the potentially free coins that Ether holders may receive.

Airdrops can also cause discounts on futures prices as holders of a derivative contract will not receive the allotment, but this is not the only case behind a decoupling as each exchange has its own pricing and risk mechanism. . For example, Polkadot quarterly futures on Binance and OKX traded at a discount to the DOT price on spot exchanges.

Binance Polkadot Quarterly Futures Award (DOT). Source: TradingView

Notice how the futures contract traded at a 1.5% to 4% discount between May and August. This backwardation demonstrates a lack of demand from leverage buyers. However, considering the long-lasting trend and the fact that Polkadot was up 40% from July 26 to August 12, external factors are likely to be at play.

The futures contract price has been decoupled from the spot exchanges, so traders have 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, which is the ability to trade amounts greater than the initial deposit (guarantee or margin).

Let’s consider a scenario where an investor deposited $ 100 and buys (long) $ 2,000 USD of Bitcoin (BTC) futures using 20x leverage.

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While trading fees on derivatives are generally lower than spot indicators, a hypothetical 0.05% fee applies to the $ 2,000 trade. Therefore, entering and exiting the position only once will cost $ 4, which is equivalent to 4% of the initial deposit. It might not sound like much, but such a toll weighs as the turnover increases.

While traders understand the additional costs and benefits of using a futures instrument, an unknown element tends to arise only in volatile market conditions. A decoupling between the derivative contract and the regular spot exchanges is usually caused by liquidations.

When a trader’s collateral becomes insufficient to cover the risk, the derivatives trading has an integrated mechanism that closes the position. This liquidation mechanism could cause drastic price action and consequent decoupling from the index price.

While these distortions do not trigger further liquidations, uninformed investors could react to price fluctuations that only occurred in the derivatives contract. To be clear, derivatives exchanges rely on external price sources, usually from normal spot markets, to calculate the price of the benchmark index.

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 on liquidation should be analyzed when trading on the futures markets.

The views and opinions expressed herein are solely those of author

and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your research when making a decision.