A futures contract is a legal agreement to buy or sell a cryptocurrency at a predetermined price on a specified future date. Such contracts thus have standardized parameters (quantity, price, date, etc). Also, both the buyer and the seller are legally obliged to respect the contract terms at the time of expiry.
Traders mainly use futures contracts for one of the two reasons:
- Risk management: To hedge against future price changes
- Speculation: Used for profit maximization
Important parameters in a futures contract
- Forward price: The predetermined price that the two parties have agreed upon.
- Margin: It is very important to understand the margin. The margin amount is deposited with the exchange on good faith. Essentially, it reduces the risk for the exchange and helps them to manage the day-to-day operations of the position. It is important to note that both parties need to lodge a margin of the value of the contract. For non-volatile commodities, the margin is as low as 2%. For volatile commodities like cryptocurrencies, the margin can be as high as 40%.
- You purchase Bitcoin futures at $9,000
- The margin is 40%
- The trader needs to put up 40% of $9,000 = $3,600 of capital only
- Contract unit: The actual amount of the underlying cryptocurrency which a single futures contract represents.
- Stop loss: Understand when you want to get out by taking a loss, in case the trade turns against you.
- Leverage: Leverage is the ability to control a large contract value with a relatively small amount of capital. The more the leverage the more the risk and higher the rewards.
- Contract expiration: Contract expiration is the date at which futures contracts expire and end trading activity. All price estimations happen within the period of the contract.
- Source of prices: Small fluctuations in prices matter a lot. It is thus important to understand the source of price. For example, Kraken bases its futures prices on aggregated indices. However, CBOE Bitcoin futures are settled based on the Gemini crypto exchange auction price for Bitcoin.
- Contract settlement: Whether the settlement is via cash or with the underlying asset.
- Liquidation price: Future contracts do not wait for price corrections and usually liquidate an amount if the loss reaches a certain threshold. So, it is important to understand the liquidation price that the amount of collateral allows you.
- Fees: Every transaction incurs a fee. However, the soon to be launched Digitex Futures platform will allow you to trade for free using their token, DGTX.
- Limits: Some exchanges put limits. They trigger temporary and permanent halts when rapid price fluctuations happen.
The below parameters are very important before you start futures trading:
- You need to have adequate trading skills. Also, you need to understand market sentiments and movements.
- Understanding the direction and timing of market movements is almost mandatory.
- Do not be greedy. Use leverage carefully. Identify how much risk you want to take.
- Have a plan.
- Access to a good monitoring tool (mobile friendly).
- Taking long positions: Traders take long positions when they anticipate an increase in price. So, if the price indeed goes up, the trader can make a profit. Leverage positions will provide profit in multiples. A price decrease will, however, result in a loss (multiplied due to leverage positions).
- Taking short positions: A trader goes for a short position in case he envisions a sell-off. In this case, a rise in the prices will mean incurring losses.
- Pullback strategy: After a decent bull run, the market reaches a peak. Traders start selling for profit. Here, timing is important. If a peak is identified, short orders can be placed. In case the price has already retraced, you can place a long position.
- Breakout trading strategy: When an asset is breaking out of its support or resistance level, it is advisable to take a position in the direction of the breakout.
Risk management tips from Digitex Futures
You need to calculate how much leverage you want to take. Risk management and position sizing are important. Your vision should be not only to maximize your profits but also to minimize your losses. Hence, placing a stop-loss order is important. You need to create your calculator and all decisions need to be logical. Eliminate random data points as much as you can.
As a rule of thumb, most retail investors risk no more than 2% of their investment capital on any single trade, and hedge fund managers usually risk less than this amount, according to Investopedia.
How much capital can you lose?
The industry benchmark is 2%. If your investment capital is $1,000, be ready to accept a risk of losing $20 of your capital. No more than that! As we said before, do not be greedy.
What will be your leverage position?
With the high probability of a long trade underway, you need to remember first that your maximum account risk is at 2% so you cannot risk more than $20 per trade, assuming that your investment capital is $1,000.
Current Ethereum (ETH) price: $199
Fix your stop loss. In this example, we will take the value as $197 (ideally a few cents below the recent low).
For a long position around the current price levels of $199, the trade risk is $2 per ETH.
Dividing your account risk, which is $20 per trade, by the trade risk, which is $2 per ETH, you will determine that the right position size for this long trade is up to 10 ETH.
More details can be found in a Digitex Futures article, here.
Also, read our article on Spectacular Start: Bitcoin Futures Trading Doubles that we covered at the start of this year.
90% of people lose money in Futures Trading. That is a risk you take for high returns. For you to be at the remaining 10%, you need to have adequate knowledge and understanding of the market. Also, you need a good platform to trade. Understand your risk-taking capabilities and have a clear objective.
The information discussed by Altcoin Buzz is not financial advice. This is for educational and informational purposes only. Any information or strategies are thoughts and opinions relevant to accepted levels of risk tolerance of the writer/reviewers and their risk tolerance may be different than yours. We are not responsible for any losses that you may incur as a result of any investments directly or indirectly related to the information provided.
Do your own due diligence and rating before making any investments and consult your financial advisor. The researched information presented we believe to be correct and accurate however there is no guarantee or warranty as to the accuracy, timeliness, completeness. Bitcoin and other cryptocurrencies are high-risk investments so please do your due diligence. Copyright Altcoin Buzz Pte Ltd. All rights reserved.