Fundamental aspects of futures trading
In this article, we will strive to explain the key aspects of futures trading in plain language, without delving too deeply into the details, and examine the main opportunities offered by this type of trade.
- What are futures in trading?
- How to use leverage and how to calculate it?
- Liquidation price and loss realization
- Appropriate risk management
- Releasing funds for additional trade
- Results manipulation in Telegram channels
- The conclusion
Futures contracts are legal agreements that involve obligations, whereby two parties agree to exchange a specific asset at a specified price in the future. Purchasing a futures contract doesn't grant ownership rights to the asset.
In the futures trading section of any cryptocurrency exchange, you will find a leverage control panel. Regardless of the exchange you choose for trading, the implementation of this feature will be fairly similar. We will provide further examples using the Binance exchange as a reference.
The leverage control option can be found in the top right corner. Clicking on it will reveal a menu.
Through this menu, users have the option to select their desired leverage size, and they can activate it by clicking the "Confirm" button.
How to use leverage and how it calculated?
Let's consider a situation where you have a trading deposit of $2000, and you open a spot trade with a volume of $1000. The price of the asset you bought increases by 10%. After completing the trade, your profit will be 10% of the amount involved, which is $100. Your balance will be $2100 and the overall growth of your trading deposit will be 5%.
If you open the same trade on futures with 10x leverage, using the same volume of $1000 as shown in the screenshot above, you will experience a multiplication effect of the asset's price movement by the chosen leverage. In other words, the asset's growth will not be 10%, but 100% 😱. As a result, with a similar price increase of 10% as in the case of the spot trade, your profit per futures trade will be $1000 😱, which will be equivalent to a 50% increase in your deposit.
Sounds appealing, doesn't it? What if you set the leverage to 20x? How about 50x? Potentially, incredible profits can be achieved, right?
This is where "potentially" becomes main word in this phrase. Because potentially, it can also result in a loss, which is formed by multiplying the capital participating in the trade by the leverage. In the discussed scenario where you open a trade with 50% of your deposit ($1000) and with 10x leverage, even a slight asset's price movement 5% in the opposite direction could potentially result in a loss of $500, equaling a quarter of your total trading deposit.
Liquidation price and loss realization
Regardless of the type of trades you engage in, whether it's spot trading or futures trading, as long as your trade is open, the current loss is considered "virtual." The actual damage to your deposit occurs only when you close the trade at a loss, thus realizing and transforming it from a virtual state into a real loss of your funds.
Going back to our example, it becomes apparent that in spot trading you have the ability to wait out unfavorable periods of price decline. After all, you have the right of ownership over the acquired asset and can hold onto it for as long as you deem necessary.
In futures trading, the situation is quite different. Firstly, you will have to pay fees to the exchange on a daily basis for holding your contract. Therefore, prolonged holding of the asset becomes problematic and may not always be advisable. Secondly, unlike in spot trading, there is a liquidation/bankruptcy price for your deposit in futures.
The liquidation price is a critical value of the asset, indicating its deep unprofitability. When this price level is reached, the system initiates the liquidation/reduction of the trader's open positions to prevent account bankruptсу.
This price depends on several factors: the size of the leverage, the margin maintenance rate, the current price of the asset and the current state of the deposit.
Trader must maintain a certain amount of "free" funds to ensure that the exchange keeps his futures contracts open. Reducing this reserve is a signal to the exchange of the potential risk that the trader may not be able to repay the borrowed funds. In such case, the exchange may preemptively reduce the trader's trading volume (or liquidate positions) to ensure he has enough funds to settle his debt with the exchange.
Returning to our example with an open futures trade of $1000 with 10x leverage. In case when the asset moves in the opposite direction by -10%, it will be multiplied by the 10x leverage, resulting in a loss of -100% on the trade, which is -$1000. This would be equal to a loss of half of the trader's deposit. However, trader still has some remaining free margin of $1000 that wasn't used in the current trade. If the cross margin mode was selected for the trade, it will not be closed. Instead, the available funds will be utilized to maintain the position. However, if the price continues to move unfavorably by another -10%, trader will lose all his funds and his account will be liquidated.
Therefore, it becomes apparent that with the current parameters of the trade in our example, the liquidation/bankruptcy price of the trader's account will be equal to a 20% movement of the asset in the opposite direction (if the cross-margin option is activated).
When you have an open position in futures, you can easily find the liquidation price of that trade, which will be dynamically updated in real-time based on the parameters described above.
There are two margin modes: Cross and Isolated.
Isolated margin is an individually allocated amount of funds for a specific trade. This margin type enables you to restrict losses to the initial designated amount of money assigned to the trade.
In the case of our example, where a trade of $1000 with 10x leverage is open in isolated margin mode, the position will be automatically liquidated if the price moves -10% (-10% * 10 = -100%). In other words, the liquidation price will be placed on the chart at a distance of -10% from the entry point of the trade.
Please note that the calculation of the liquidation price actively involves the leverage, which multiplies the price movement of the asset. By adjusting the leverage, you can adjust the liquidation price. A trade with isolated margin mode is automatically closed when a loss of -100% is reached, taking into account the leverage multiplication.
So if the price continues to move against the trader's expectations, he will not lose his entire deposit because the trade will be automatically closed when the price reaches the -10% mark from the entry point.
Cross-margin is a margin mode where all available funds in the trader's account at the current moment act as supporting margin. In our example, choosing this margin mode would allow the trader to hold the trade even if the asset's movement reaches -20% instead of automatically closing it earlier.
Okay, what if you had opened a futures trade just with $200, which is only 10% of the total size of your deposit?
Then, with the cross-margin mode for the liquidation/bankruptcy of your deposit, the price of the asset would have had to drop not by -20% of its value, but by a whopping -100%. Therefore, the only scenario in which your deposit could have been forcefully liquidated is if the price of the asset reached zero (what is nearly impossible).
As seen from the screenshot above, the smaller the portion of the deposit involved in the trade, the further the asset price needs to move in the negative direction to cause liquidation. Therefore, if the trade involves less than 10% of the total deposit size with 10x leverage, you can be confident that your trade will not be liquidated by the exchange.
In addition to the portion of the deposit involved in the trade, you can manage liquidation risks by adjusting the leverage:
If we compare the results of trades in which the asset price increased by 10%, but in the first case, a spot trade was opened with a volume equal to 50% of the trading deposit, and in the second case, a futures trade was opened with 10% of the deposit size, the outcomes would be as follows
Thus, futures trading allows you to get significant results even with a small portion of the deposit involved in the trade. In the case of spot trading, using our example where you have $2000 in your trading account and opening a trade with $1000, you can only open two trades simultaneously. However, with futures trading, having the same $2000, you can open nearly ten trades simultaneously and the potential for profit will be disproportionately higher compared to spot trading.
Releasing funds for additional trade
Among inexperienced traders, there is a belief that leverage is a tool for increasing potential profits. In fact, the primary benefit of utilizing leverage is the opportunity to "unburden" the deposit, which allows simultaneous participation in a larger number of trades.
For example, you have evenly divided your $2000 into 10 trades (each $150), set a leverage of 10x, and opened your trades. At that moment, you notice an excellent opportunity to open a trade with a high probability of profit. However, you realize that you don't have available funds. In this scenario, in real-time, you have the ability to adjust the leverage that is applied to your already open trades.
The table above is divided into two sections. The left section shows that there are 10 trades opened, each with a size of $150 and leverage of 10x. The total value of all the trades is $1500, but considering the leverage, it becomes $15000. In this case, you cannot afford youself to open another trade for $500 as you don't have the available funds. However, if you change the leverage for each opened trade from 10x to 30x (as shown in the right section of the table), all the funds involved in the trades will amount $15000 (considering leverage), but without leverage, the total value of your trades would be only $500 (because you are utilizing higher leverage to compensate this difference).
Therefore, you can easily free up the necessary amount of funds to open additional parallel trades. This is precisely why leverage exists.
Results manipulation in Telegram channels
Through the example of unburdening the deposit using leverage, it has become evident that completely different variables in the combination % of deposit + leverage can lead to identical outcomes. However, ☝️ the presentation of such results to the public can vary.
Undoubtedly, you often come across such results online. Take note of the leverage. If you divide such an impressive profit percentage as 393.99% by the leverage size (200x), you will get a price change of only 1.96%. It is unlikely that such a modest price movement would generate the same level of excitement as the impressive profit of nearly 400% per trade.
The table above illustrates the interdependence between trade size and leverage in relation to trade outcomes. In this example, seven trade variations resulted in identical outcomes, where the trading deposit increased by 1%. However, if we look at the "Profit in trade, %" column, instead of a modest 1% deposit growth, we see incredible results such as +150%, +200%, or even +400% profit per trade. In this form, these data hold absolutely no value. Despite this, many bloggers regularly employ such manipulative practices to exaggerate their performance.
This article leads to the following conclusions:
- Futures trading is more suited for short-term or medium-term trading rather than long-term investments
- Leveraged trading allows you to participate in a large number of simultaneous transactions, thereby increasing capital efficiency
- Alongside the potential opportunities for increasing income, futures also come with proportional possibilities for generating losses
- Losses can be minimized through the implementation of a high-quality trading algorithm and appropriate risk management (read about it in a separate article)
- Insufficient focus on risk management greatly raises the probability of position liquidations or the bankruptcy of your account
- The profit data considering leverage in a trade holds no value. It is always essential to assess a trade based on the increase in the trading deposit after its closure.