3 Main Mistakes to Avoid When Trading Cryptocurrency Futures Markets – Cointelegraph | Jewelry Dukan

Many traders frequently share some relatively big misconceptions about cryptocurrency futures trading, especially on derivatives exchanges outside of the realm of traditional finance. The most common errors relate to futures market price decoupling, 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.

Derivative contracts differ from spot trading in pricing and trading

Currently, aggregate futures open interest in the crypto market exceeds $25 billion, and retailers and veteran fund managers are using these tools to leverage their crypto positions.

Futures contracts and other derivatives are often used to reduce risk or increase exposure and, despite this popular interpretation, are not really intended for degenerate gambling.

Some differences in pricing and trading are typically overlooked in crypto derivative contracts. For this reason, traders should at least consider these differences when venturing into the futures markets. Even savvy derivatives investors from traditional investments make mistakes, so it’s important to understand the ins and outs before using leverage.

Most crypto trading services do not use US dollars, even when they display USD rates. This is a great untold secret and one of the pitfalls faced by derivatives traders, which introduces additional risks and distortions to trading and analyzing futures markets.

The pressing problem is the lack of transparency, so customers don’t really know if the contracts are priced in stablecoin. However, this shouldn’t be a huge problem considering there is always a risk of an intermediary when using centralized exchanges.

Discounted futures sometimes bring surprises

As of Sept. 9, Ether (ETH) futures expiring Dec. 30 are trading for $22, or 1.3% below the current price, on spot exchanges such as Coinbase and Kraken. The difference comes from the anticipation of merge fork coins that could emerge during the Ethereum merge. Buyers of the derivatives contract will not receive any of the potentially free coins that Ether holders may receive.

Airdrops can also result in reduced futures prices as derivatives contract holders don’t win, but that’s not the only case behind decoupling, as each exchange has its own pricing mechanism and risks. For example, quarterly polkadot futures on Binance and OKX have been trading at a discount to the polkadot (DOT) price on spot exchanges.

Binance Polkadot (DOT) quarterly futures premium. Source: TradingView

Notice how the futures contract traded at a discount of 1.5% to 4% between May and August. This backwardation shows a lack of demand from leveraged buyers. However, given the long-term trend and the fact that Polkadot is up 40% from July 26 to August 12, external factors are likely at play.

The futures contract price has decoupled from spot exchanges, requiring traders to adjust their targets and entry levels when using quarterly markets.

Higher fees and price decoupling should be considered

The main benefit of futures contracts is leverage, or the ability to trade amounts larger than the initial deposit (collateral or margin).

Consider a scenario where an investor has deposited $100 and buys $2,000 worth of (long) Bitcoin (BTC) futures with 20x leverage.

Although trading fees for derivative contracts are typically lower than for spot markers, a hypothetical fee of 0.05% applies to $2,000 trades. Therefore, entering and exiting the position once costs $4.00, which is 4% of the initial deposit. That might not sound like a lot, but such a toll weighs as sales increase.

Even when traders understand the additional costs and benefits of using a futures instrument, an unknown element usually only reveals itself in volatile market conditions. The decoupling between the derivative contract and the regular spot exchanges is usually caused by liquidations.

When a trader’s collateral is no longer sufficient to cover the risk, the derivatives exchange has a built-in mechanism that closes the position. This liquidation mechanism could lead to drastic price movements and a resulting decoupling from the index price.

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

There is nothing wrong with these unique processes, but all traders should consider their implications before using leverage. Price decoupling, higher fees and liquidation implications should be analyzed when trading in futures markets.

The views and opinions expressed here are solely those of author and do not necessarily reflect the views of Cointelegraph. Every investment and trading movement involves risk. You should do your own research when making a decision.