Top 3 Mistakes Crypto Derivatives Traders Make
Derivatives trading has
taken the crypto world by storm. As a matter of fact, the open interest
of Bitcoin futures and swaps has already exceeded $4 billion at the start of
2020, according to Skew Analytics (skew.com), up from $1 billion at the start of
2019. Want more background context on what derivative trading is
about? Here is a short guide! The appeal of high leverage (up to 125x),
low commissions, high liquidity and the innate volatility of
cryptocurrencies have resulted in an increase in interest in derivatives
trading, especially in the ubiquitous Bitcoin perpetual swap. This
financial instrument, designed to mimic the price movement of the spot
BTC/USD index, is now offered by most cryptocurrency exchanges.
However, in their eagerness to enter the fray and quickly “double” their
capital, cryptocurrency traders overlook certain
characteristics of the perpetual swap that makes it different from spot margin
trading. Here are the top three mistakes that you need to avoid while
trading perpetual swaps! Leverage: The ability to take on more
risk exposure, usually expressed as a multiple of collateral deposited
(e.g. taking on 10 BTC of risk with only 1 BTC deposited translates to
10x leverage). Liquidity: How easily a market order can be filled
without impacting the overall market price. Market Order: An order
which aims to be filled immediately by resting limit orders,
regardless of price. Traders use this type of order when execution of the
order immediately is of high priority. Open interest: The total number of
outstanding derivative contracts as open positions, often used as an
indicator to gauge the speculative intent of traders as a whole.. Most
crypto derivative exchanges allow you to access up to 100x worth
of leverage. This means that for every 1 BTC you deposit, you can control
up to 100 BTC in an open position. While it sounds really attractive to
be able to double your capital in a small 1% move in BTC prices
(BTC moves on average about 4% a day), the reverse is also true. You can lose
your entire capital in a mere >1% move. Open/close: The price at which a
market opens at a time period, for example, at the start of the
day; the price at which a cryptocurrency closes at a time period, for example,
at the end of the day. In general, these terms are more useful in traditional
financial markets, as there are fixed hours of the day in which trading
occurs. The “breathing room” for a trade increases as leverage decreases.
It is loosely given by this formula: The higher the leverage you use, the
nearer your liquidation price becomes. If you use 100x, the
liquidation price is a mere ~1% away. If you use a more conservative 5x
leverage, the liquidation price becomes a more comfortable ~25%
away. Given the volatile nature of cryptocurrencies, always ensure that
you are not over-leveraged as you might get “stopped out” before your
trade idea comes into fruition. I would recommend a leverage of not more
than 5x for most swing traders as you would want to buffer for huge
potential spikes in markets (which happen more often than not in the
cryptocurrency space). Most derivative exchanges utilize two
different prices in managing positional risks of traders:
liquidation price and bankruptcy price. The reason for the
difference is purely for risk management on the exchange’s part. As
traders put large amounts of leverage in a volatile market,
there will be instances where huge slippage happens when a trader’s
portfolio undergoes bankruptcy. This means that the losing trader
has now lost more money than he has collateral — and someone needs to pay the
winning trader. In order to ensure that all winning traders are
paid, most exchanges have an insurance fund in place that
guarantees the payout for traders on the right side of the market. And in
order to ensure that the insurance fund has sufficient capital, some
exchanges force a position to undergo liquidation before
the trader’s account hits its bankruptcy price, and the
difference between the two prices end up as money deposited into
the insurance fund. If you allow your position to be liquidated by the exchange,
you will end up losing more than if you had used a stop-loss order in place of
auto-liquidation. This difference becomes huge when a trader
utilizes high leverage and is one of the biggest mistakes a trader can make. Joe
puts on a 100x leveraged long on BitMEX-XBTUSD, with an entry price of $10,000.
He has the following risk parameters: Liquidation price: $9,951
Bankruptcy price: $9,901 If the market trades to $9,951, the liquidation
engine kicks in and liquidates his position. It would assume an execution price
of $9,901 (his bankruptcy price) and the difference between the
two ($50) enters the insurance fund. Use this calculator to calculate your
liquidation price and manage your risks! In summary — do NOT use high
leverage and do NOT use your liquidation price as your stop-loss. Putting a stop
loss at $9,960 in the above example would ensure you get to keep the $50 you
posted and not have that money end up in the liquidation fund. In order to
encourage liquidity on derivative exchanges, most exchanges offer rebates for
“maker” orders, which are orders that wait for a fill instead of entering the
market immediately. While the commission difference between a
“maker” order and a “taker” order might seem insignificant (a 0.025% rebate over
a 0.075% fee), these fees add up over time. The difference between
a maker and a taker is 0.1% in fees. Assuming Joe buys and sells 2 BTC in volume
every day, the difference between “making” all and “taking” all would be
the following: Savings per day: 0.1% * 2 BTC = 0.002 BTC Savings per
month: 0.002 BTC * 30 days = 0.06 BTC Savings per year: 0.06 BTC * 12 months =
0.72 BTC The difference between “making” and “taking” may seem small, but
patience in waiting for a fill goes a long way. After all, it is also good
practice to “buy into dips” and “sell into rallies” when swing trading, so why
not get paid while doing so! CoinMarketCap has recently expanded our listings to
include derivative markets. Check it out here! This article is intended
to be used and must be used for informational purposes only. It is important to
do your own research and analysis before making any material decisions. This
article is not intended as, and shall not be construed as, financial advice. The
views and opinions expressed in this article are the author’s own and do not
necessarily reflect those of CoinMarketCap.
Derivatives trading has
taken the crypto world by storm. As a matter of fact, the open interest
of Bitcoin futures and swaps has already exceeded $4 billion at the start of
2020, according to Skew Analytics (skew.com), up from $1 billion at the start of
2019. Want more background context on what derivative trading is
about? Here is a short guide! The appeal of high leverage (up to 125x),
low commissions, high liquidity and the innate volatility of
cryptocurrencies have resulted in an increase in interest in derivatives
trading, especially in the ubiquitous Bitcoin perpetual swap. This
financial instrument, designed to mimic the price movement of the spot
BTC/USD index, is now offered by most cryptocurrency exchanges.
However, in their eagerness to enter the fray and quickly “double” their
capital, cryptocurrency traders overlook certain
characteristics of the perpetual swap that makes it different from spot margin
trading. Here are the top three mistakes that you need to avoid while
trading perpetual swaps! Leverage: The ability to take on more
risk exposure, usually expressed as a multiple of collateral deposited
(e.g. taking on 10 BTC of risk with only 1 BTC deposited translates to
10x leverage). Liquidity: How easily a market order can be filled
without impacting the overall market price. Market Order: An order
which aims to be filled immediately by resting limit orders,
regardless of price. Traders use this type of order when execution of the
order immediately is of high priority. Open interest: The total number of
outstanding derivative contracts as open positions, often used as an
indicator to gauge the speculative intent of traders as a whole.. Most
crypto derivative exchanges allow you to access up to 100x worth
of leverage. This means that for every 1 BTC you deposit, you can control
up to 100 BTC in an open position. While it sounds really attractive to
be able to double your capital in a small 1% move in BTC prices
(BTC moves on average about 4% a day), the reverse is also true. You can lose
your entire capital in a mere >1% move. Open/close: The price at which a
market opens at a time period, for example, at the start of the
day; the price at which a cryptocurrency closes at a time period, for example,
at the end of the day. In general, these terms are more useful in traditional
financial markets, as there are fixed hours of the day in which trading
occurs. The “breathing room” for a trade increases as leverage decreases.
It is loosely given by this formula: The higher the leverage you use, the
nearer your liquidation price becomes. If you use 100x, the
liquidation price is a mere ~1% away. If you use a more conservative 5x
leverage, the liquidation price becomes a more comfortable ~25%
away. Given the volatile nature of cryptocurrencies, always ensure that
you are not over-leveraged as you might get “stopped out” before your
trade idea comes into fruition. I would recommend a leverage of not more
than 5x for most swing traders as you would want to buffer for huge
potential spikes in markets (which happen more often than not in the
cryptocurrency space). Most derivative exchanges utilize two
different prices in managing positional risks of traders:
liquidation price and bankruptcy price. The reason for the
difference is purely for risk management on the exchange’s part. As
traders put large amounts of leverage in a volatile market,
there will be instances where huge slippage happens when a trader’s
portfolio undergoes bankruptcy. This means that the losing trader
has now lost more money than he has collateral — and someone needs to pay the
winning trader. In order to ensure that all winning traders are
paid, most exchanges have an insurance fund in place that
guarantees the payout for traders on the right side of the market. And in
order to ensure that the insurance fund has sufficient capital, some
exchanges force a position to undergo liquidation before
the trader’s account hits its bankruptcy price, and the
difference between the two prices end up as money deposited into
the insurance fund. If you allow your position to be liquidated by the exchange,
you will end up losing more than if you had used a stop-loss order in place of
auto-liquidation. This difference becomes huge when a trader
utilizes high leverage and is one of the biggest mistakes a trader can make. Joe
puts on a 100x leveraged long on BitMEX-XBTUSD, with an entry price of $10,000.
He has the following risk parameters: Liquidation price: $9,951
Bankruptcy price: $9,901 If the market trades to $9,951, the liquidation
engine kicks in and liquidates his position. It would assume an execution price
of $9,901 (his bankruptcy price) and the difference between the
two ($50) enters the insurance fund. Use this calculator to calculate your
liquidation price and manage your risks! In summary — do NOT use high
leverage and do NOT use your liquidation price as your stop-loss. Putting a stop
loss at $9,960 in the above example would ensure you get to keep the $50 you
posted and not have that money end up in the liquidation fund. In order to
encourage liquidity on derivative exchanges, most exchanges offer rebates for
“maker” orders, which are orders that wait for a fill instead of entering the
market immediately. While the commission difference between a
“maker” order and a “taker” order might seem insignificant (a 0.025% rebate over
a 0.075% fee), these fees add up over time. The difference between
a maker and a taker is 0.1% in fees. Assuming Joe buys and sells 2 BTC in volume
every day, the difference between “making” all and “taking” all would be
the following: Savings per day: 0.1% * 2 BTC = 0.002 BTC Savings per
month: 0.002 BTC * 30 days = 0.06 BTC Savings per year: 0.06 BTC * 12 months =
0.72 BTC The difference between “making” and “taking” may seem small, but
patience in waiting for a fill goes a long way. After all, it is also good
practice to “buy into dips” and “sell into rallies” when swing trading, so why
not get paid while doing so! CoinMarketCap has recently expanded our listings to
include derivative markets. Check it out here! This article is intended
to be used and must be used for informational purposes only. It is important to
do your own research and analysis before making any material decisions. This
article is not intended as, and shall not be construed as, financial advice. The
views and opinions expressed in this article are the author’s own and do not
necessarily reflect those of CoinMarketCap.