Trading futures has advantages and disadvantages.
- Futures allows for the use of leverage. This is the most generally desired advantage as traders can execute orders at a lower cost.
- It allows for advanced trading methods.
- Trading futures allows one to profit from both rise in asset value and its fall.
- The high volatility in the crypto space can be a blessing or an agony. Market movement is something no one can guarantee.
- Due to the leverage involved, futures is one of the most challenging trading tools. Traders open themselves up to being liquidated and in turn, should trade them with a strong risk management strategy.
Futures traders should familiarize themselves with some essential concepts noted below. These concepts are critical to understanding the power of leverage. Critical points outlined below are essential when dealing with futures and require traders to know how they affect each trade.
Leverage is the most common reason traders are attracted to futures and is a capital multiplier. Trading with leverage allows for more advanced trading methods.
Buying an asset without leverage, requires enough money in your account to cover the asset at the current market price. With leverage, you can buy the same amount of the asset with a fraction of the required money. The higher the leverage a trader uses, the less money is needed to purchase an asset. Leverage is only available when trading futures.If you only have $1,000 avaialble to trade, making use of a 5x leverage muliplier will now allow you trade with $5,000.
An initial margin is needed to enter a futures position. Initial margin is the percentage of a futures position that must be collateralized.
Maintenance margin is the minimum amount of funds that traders need in their margin account to keep their position(s) open. When a trader's margin balance becomes equal to their maintenance margin, their position gets liquidated.
Futures traders can be forced to exit positions when their losses bring their margin balance equal to their maintenance margin requirements. When this happens inevitably trades are liquidated.
Futures require a mechanism to incentivize the market skew to remain balanced (equal long/short open interest). Funding is designed to incentivize a balance of open interest on each side of the market. Positions on the crowded side of the market will be charged funding, while positions on the noncrowded side will receive funding. Funding rates can have unfavorable effects on a traders position. For instance, funding rates may spike when the market is consistently moving in the same direction, making it costly for traders to hold onto their positions.
Becoming familiar with the basics of futures is a must. Futures trading can be lucrative if you apply risk management to avoid non-proportional losses. Traders should strategize and do research before trading futures and understand both their advantages as well as their risks.
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