What is Crypto Futures Trading: A 100% Beginner-Friendly Guide
Firstly, what are crypto futures? These are financial contracts that allow traders to speculate on the future price movements of cryptocurrencies without actually owning the underlying assets. These contracts come with specific terms and expiry dates, making them distinct from traditional spot trading.
Key terminologies in futures trading include “long” (betting on price increase) and “short” (betting on price decrease) positions, as well as “leverage” (borrowed funds for trading).
By the end of this article, you will have gained a solid understanding of what futures trading is, and how it can be used to maximize your trading gains (as well as a word or two of caution!)
How Crypto Futures Differ from Spot Trading
Unlike spot trading, where you buy and hold actual cryptocurrencies, futures trading enables you to profit from price fluctuations without owning the assets.
The key implication of this: you can bet on both rising and falling markets (using both long and short-selling), opening up opportunities even in bearish conditions.
Benefits of Crypto Futures Trading
The main reason people embark on futures trading is that it allows you to amplify your trading power by using leverage (i.e borrowed money), potentially increasing both gains and losses.
Let’s walk through this using a hypothetical example where you’re interested in trading Bitcoin (BTC), and its current price is $50,000 per BTC.
Spot Trading
You decide to buy 1 BTC at the current market price of $50,000. You invest $50,000 of your capital into Bitcoin.
If the price of Bitcoin increases by $1,000, reaching $51,000 per BTC, your gain in spot trading would be $1,000 ($51,000 — $50,000), which is a 2% return on your initial capital of $50,000.
Futures Trading with Leverage
In futures trading, you decide to enter into a Bitcoin futures contract with 10x leverage using the same $50,000 of initial capital.
With 10x leverage, your position size is 10 times your initial capital, meaning you can control 10 BTC with your $50,000.
Now, if the price of Bitcoin increases by $1,000 to $51,000 per BTC, your gain in futures trading would be $1,000 x 10 (since you control 10 BTC) = $10,000, which is a 20% return on your initial capital of $50,000.
Comparison:
- In spot trading, your gain was $1,000, which is a 2% return on your initial capital.
- In futures trading with 10x leverage, your gain was $10,000, which is a 20% return on your initial capital.
As you can see, futures trading with leverage significantly amplifies your gains compared to spot trading (as a rule of thumb, those who are new to futures trading can start with a leverage of 2x or 5x).
However, it’s essential to note that leverage not only amplifies gains but also magnifies potential losses. Therefore, while the potential for higher profits exists, so does the risk of incurring substantial losses.
Which leads us to the next section…
Can you lose more than your initial capital in futures trading?
Yes, in futures trading, it is possible to lose more than your initial capital. This occurs due to the concept of leverage, which is a double-edged sword in trading.
As we have seen earlier, leverage allows traders to control a larger position size with a relatively smaller amount of capital. But while leverage can amplify potential profits, it also magnifies potential losses.
Let’s break down how a Bitcoin trader can get margin-called in crypto futures trading, assuming they have an initial capital of $1,000 and are taking a short position*. In this scenario, we’ll assume an example with 10x leverage to illustrate the concept.
*Short Position: Taking a short position means you’re betting that the price of Bitcoin will decrease. You borrow Bitcoin (BTC) from the exchange and sell it at the current market price, with the intention of buying it back later at a lower price to repay the borrowed Bitcoin.)
Initial Capital: $1,000
Leverage: 10x (With this 10x leverage, the trader can control a position size that’s 10 times their initial capital. In this case, they can control a position size of $10,000 worth of BTC with their $1,000 initial capital.)
Short Position with 10x Leverage: The trader decides to short $10,000 worth of BTC at a market price of $50,000 per BTC. He is effectively shorting 0.2 BTC ($10,000 / $50,000 per BTC). The total value of his short position is $10,000.
Margin Requirement: Now, with 10x leverage, the margin requirement is typically a percentage of the position’s value. In this example, let’s assume a margin requirement of 10% of the position value. His margin requirement = 10% of $10,000 = $1,000
Scenario
- The price of Bitcoin starts to rise, and the trader’s short position incurs unrealized losses.
- Suppose the price of Bitcoin rises to $51,000, resulting in a $1,000 unrealized loss on their short position.
Margin call and liquidation:
- Since the margin requirement is $1,000, the trader’s account balance (initial capital) is no longer sufficient to cover the required margin.
- The exchange issues a margin call for $1,000 to cover the growing losses.
- If the trader cannot deposit the additional $1,000 to meet the margin call, the exchange may forcibly close their position through liquidation.
Liquidation example:
- The exchange liquidates the trader’s position at the current market price of $51,000 for $10,000 worth of BTC.
- This means the trader buys back $10,000 worth of BTC at $51,000, incurring a total loss of $1,000 (equal to the margin requirement).
- After liquidation, the trader’s account balance would be reduced to zero.
In this example with 10x leverage, the trader’s initial capital of $1,000 allowed them to control a larger position size of $10,000 worth of BTC. However, the use of leverage also exposed them to higher risk. As the price of Bitcoin moved against their short position, their losses grew and eventually exceeded the margin requirement, leading to a margin call and liquidation.
This example illustrates the importance of understanding leverage, margin requirements, and risk management when trading with leverage in the cryptocurrency futures market. It’s crucial to use leverage responsibly and ensure that you have adequate capital to cover potential losses and margin requirements.
Risk Management Techniques in Crypto Futures Trading
To mitigate the risk of losing more than your initial capital in futures trading, it’s crucial to:
- Use leverage cautiously and responsibly, considering your risk tolerance. Traders who use excessive leverage without proper risk management can quickly find themselves in a situation where a relatively small price movement can wipe out their entire trading account and more. Overleveraging is a common mistake that inexperienced traders make.
- Use stop-loss and take-profit orders: Set these orders to limit potential losses and lock in profits.
- Determine your position sizing: Determine the appropriate size for your trades based on your risk tolerance.
- Diversification: Avoid putting all your funds into a single trade; diversify your portfolio.
Technical Skills For Crypto Futures Trading Success
There are 2 types of analysis traders undertake when it comes to futures trading. The first kind is fundamental analysis, otherwise known as simply keeping up with the markets and staying informed about crypto news and events that can influence market sentiment.
The other kind is known as technical analysis, which is less intuitive but will help you up your game as a crypto trader. Here are some key ones to learn first:
- Candlestick patterns: Study candlestick charts to identify potential price reversals.
- Moving averages: Analyze moving averages for trends and potential entry/exit points.
- RSI (Relative Strength Index) and MACD (Moving Average Convergence/Divergence): Utilize these indicators to gauge overbought or oversold conditions.
Conclusion
Crypto futures trading presents an exciting opportunity to profit from the ever-changing world of cryptocurrencies. With the right knowledge, strategies, and risk management, you can unlock its potential while mitigating the associated risks. The future of crypto futures trading holds promise, but it’s essential to approach it with diligence, discipline, and continuous learning.
