Trading 101: What is Futures Trading?
This article conveys the basic knowledge of futures trading, basic strategies and how futures trading is changing the crypto landscape.
Getting Started: The Basics of Futures Trading
The futures market is multifaceted. It provides unlimited investment opportunities with an endless variety of options for the underlying or expiration. At its best, it helps traders improve their capital allocation with the introduction of margin and leverage, hedge portfolio risks and smooth out turbulences.
What are Futures Contracts?
A futures contract is simply an agreement between two parties to transact a particular asset at a specific future time, at a negotiated price. The most celebrated attribute of futures contracts lies in their standardisation: futures are virtually exchange-traded, therefore have to follow the same terms and conditions of exchanges. Most traders enjoy futures trading because of the elevated liquidity, which comes with a much lower probability of default.
To operate, each futures contract must contain the following elements:
The underlying asset (often referred to as the underlying): This is the “source” of futures value. A futures contract can be written on commodities, stocks, interest rates, even digital currencies.
The expiration date
The settlement method, i.e. should sellers deliver the actual underlying asset when futures expire, or are they being quoted the associated cash positions?
How do they work?
Futures work as a speculation on future prices of the underlying. Buyers can either bet on a price increase and open a long position or expect price levels to decline and short the contracts. Indeed, the outstanding positions in futures markets reflect the collective confidence towards the underlying industry. Portfolio managers usually turn to futures to effectively and economically reduce their exposure to other assets.
Benefits of futures markets
The three major functions of futures markets include risk transfer and price discovery. Due to uncertainties regarding the existing investments, many use futures as a tool for managing risk: the more vulnerable will transfer their portfolio risks to counterparties that are able to absorb them at reasonable transaction costs. Hence, risk build-up is substantially curbed.
The capital requirements for futures are significantly lower than the actual purchase of underlying assets, thus ushering in the expectations for spot markets. Take the U.S. futures market as an example. It always opens before the U.S. stock market, revealing sentiment of market participants as well as encouraging traders to implement appropriate strategies. In addition, the price locked-in in futures contracts should be equivalent to the risk-neutral future price for asset holders and allow for better position evaluation.
Futures Investing
As futures are more sophisticated trading products, futures investing should be executed consciously. It is important to be familiar with contract types and clearly determine your preferred means of settlements (physical or cash settlement).
Conventional vs. Perpetual Contracts
Most futures contracts are conventional, that is, the expiration date is specified in the contract. If the contract price approaches the spot price near settlement date, all related positions will expire (meaning they get settled).
Conversely, perpetual contracts don’t have an expiration date. Traders can hold their positions forever and close them at any time they want. Another crucial difference is perpetual contracts are written on an asset’s index price, which equals the average price of that particular asset with respect to its spot price and trading volume. As a result, these types of futures are mostly exchanged hands at a price very close to the underlying spot price.
One may ask why trade perpetual futures if it’s similar to spot markets? As perpetual contracts are futures with no expiration, the market is impressively liquid. Trading perpetual doesn’t require constant monitoring as spot, incur less costs and eliminate the need to own the actual assets.
Interconnected: Margin and Leverage
Criticisms about futures trading centred mostly on the fact that they are highly leveraged instruments. However, as mentioned above, traders need to participate in these markets in a mindful and responsible manner to avoid less favourable outcomes.
Two concepts all futures traders must encounter are margin and leverage. Margin is the amount of capital traders are required to deposit into their margin account before opening a new position. With collaterals as proof of traders’ ability to honour their contract obligations, they can exploit the borrowed capital, a.k.a leverage, from exchanges to undertake a new investment.
Margin requirements and leverage levels vary between exchanges, but rules remain the same: the lower the volatility of the underlying, the higher the leverage available for its futures contracts. Our Trading 101 section also covers the topic of margin trading here.
Popular Futures Trading Strategies
Portfolio managers can combine different trading strategies for their futures portfolios. Here we will introduce the most versatile, easy-to-use techniques for both seasoned and newbie traders.
The pullback strategy
This powerful strategy is created to take advantage of price pullbacks, i.e. temporary retreats that prepare the asset for its next uptrend or downtrend. It has a close connection with the price consolidation since the asset will repeatedly test its upper- or lower bounds until a new trend emerges.
A bearish market where support level is retested.
Source: TD Ameritrade.
The upper bound of prices, resistance level, can be found during a rally where prices have difficulties climbing up. It is best to long futures contracts after the asset successfully establishes a new resistance level. On the contrary, short selling is advised for the bearish market when (spot) prices retest the support levels (lower bounds).
Trend-following
Traders can observe the underlying market and make their own forecasts of the market trend over a certain period of time. If there’s enough evidence that we are in a bullish cycle, going long will be extremely profitable with the implementation of leverage. The same theory applies for shorting futures contracts.
An upward trend with indications for long positions.
Source: TD Ameritrade.
Breakout trading
This is the most suitable for day traders as it highlights the arbitrage opportunity of outliers, i.e. when asset prices fluctuate beyond the established price range. To catch a breakout trade, one should pay close attention to pending stop orders, which give hints about the occurrence of the next consecutive volatility. Since great volatility materialised itself after a breakout, opening futures positions in times of breakouts will help traders make the most out of them.
An example of breakout trading with stop-loss and take-profit indicators.
Source: FX Trading Revolution.
Digital assets as the underlying
With cryptocurrencies being widely adopted by both individual and institutional players, there has been a growing need for indirect access to this industry as well as secure hedging options. Crypto futures came into existence as the perfect solution for investors who don’t want to directly own and handle crypto. The crypto derivatives market has been expanding exponentially over the last five years, with both traditional and crypto-native platforms joining the space. Some big names to be mentioned include CME, Deribit, Binance and Bitget.
Crypto Futures Trading with Bitget
Launched in 2018, Bitget is now the dominating crypto derivatives trading platform with multiple innovative products. The three pillars of our customer orientation are integrity, transparency, and the preservation of a true “win-win” environment for all parties involved. We also strive for an inclusive product design so that every user can find their own solution to crypto futures trading on Bitget: Bitget USDT-Ⓜ Futures and Bitget USDC-Ⓜ Futures for cautious traders, Bitget Coin-Ⓜ Futures for crypto-geeks and Bitget Copy Trade for those who want to generate a passive income stream with minimum risk. In addition, we have recently launched Bitget One-Way Mode for TradFi veterans and the innovative Bitget Index Futures to help our users manage their portfolio more efficiently (time and cost-wise).
Activities and Liquidity
Our efforts have resulted in a huge customer base of 8 million users from 100 countries and regions worldwide. In terms of scale, Bitget is indeed the world’s largest digital copy trading exchange, where over 80,000 professional traders have shared a total of US$20 million in profits. Bitget is acknowledged as the Top 3 Crypto Derivatives Exchange in terms of Liquidity by TokenInsight.
A Social Network for Crypto Derivatives Trading
To encourage crypto derivatives trading, Bitget has constantly improved our copy trade system, known as Bitget One-Click Copy Trade. The trader network of Bitget consists of experienced traders and followers, with the former mapping out a comprehensive trading strategy so that the latter can make profit just by initiating identical orders. Our design philosophy motivates the entire network to look out for each other in terms of profit maximisation.
Responsible Leverage
Bitget users can conveniently increase their returns with the use of leverage. More volatile assets will have lower leverage levels to reduce traders’ exposure to extreme price movements.
At the same time, we strictly demand that users comply with our margin requirements and introduce risk margin to help users better resist liquidation risks. One more unique feature of Bitget is profits and losses are settled on a real-time basis, representing our guarantee for a sophisticated, accurate data system. Traders will be able to manage their account commensurate with the market, thus always in the process of improving their trading knowledge and skills.
Are you intrigued by the crypto futures market? Sign up today and keep on learning with Bitget Academy!
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