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Crypto Futures Definitions and Examples: 7 Trading Terms Every Trader Should Know!

2021-08-19

TL, DR:

  • Using volume as a measurement can be helpful for traders especially if they are interested in knowing the strength of market trends. Often, volume can be used to make sense of volatility, especially in crypto markets.

  • Traders should use a leverage amount that suits them. For example, if you're conservative or new to cryptocurrency trading, a 5x or 2x leverage would be appropriate.

  • With a well-capitalized insurance fund, traders need not worry about socialized losses, as the exchange will be responsible for the deficit. Binance operates multiple insurance funds to ensure that losses are sufficiently covered in extreme volume spikes. 

Among traders and market participants, there are common vocabularies and a handful of terms that are useful to know. In fact, the ones we will be discussing here are some basic words and terms that everyone trading should know if they want to understand how futures trading works.

At the end of each section, we’ll leave a link to another article that will further explore what these terms mean, and how they can be implemented into a trade decision.

1. Funding Rates

Funding rates are periodic payments to or from traders depending on their trade direction. Funding rates calculation consists of the interest rate and the premium. Premiums are determined based on the difference between perpetual contract prices and spot prices. Meanwhile, interest rates are set to 0.03% on Binance Futures.

These rates are often used by exchanges and markets to prevent any divergences in the price of either market. Traders should be fully aware of these rates because they impact the daily holding cost of a perpetual contract position and also, they can be used as a gauge of market sentiment in the futures market. For instance, high funding rates often occur in bull markets where traders believe the market is going up so strongly that they are willing to pay a premium to go long.

More information explaining the ins and outs of funding rates can be found in our blog post.

2. Open Interest 

Open interest is a tool that can prove to be very insightful for traders. It provides, in real-time, a total number of open positions held by market participants. The open interest is founded by summing the quantity of all opened trades and then subtracting the number of trades that have been closed.

Traders often use open interest to understand how much capital is moving in and/or out of a market. When more capital is filling into the market than is leaving it, then open interest goes up. The opposite is true as well. Thus, open interest can give you an insight into market sentiment at any given time. Often open interest is considered to be closely related to volume, the next term on our list.

For further discussion on open interest, please read our article ‘What Information Does Open Interest Convey?

3. Volume

Volume is a measurement used to capture the number of individual units of an asset that are being traded in a market. When a transaction is agreed upon by price in an exchange, the data from the trade is used to update the measurement of volume in the market.

Using volume as a measurement can be helpful for traders especially if they are interested in knowing the strength of market trends. Often, volume can be used to make sense of volatility, especially in crypto markets. For example, if trading volume is high and the price of a cryptocurrency is trending upwards in a volatile fashion, the uptrend would be easily justified.

4. Leverage

Leverage is a crucial component in futures trading. It has the capacity to win a trader substantial profits on a given trade. But for just as lush as this reward may be, traders are also at risk of losing by the same magnitude. Before deciding on a degree of leverage, investors should examine generally recognized guidelines. The three most basic principles of leverage are as follows:

  • First, maintain low levels of leverage.

  • Use stop-orders to reduce downside and protect capital.

  • Limit capital to 1% to 2% of total trading capital on each position taken.

Traders should use a leverage amount that suits them. For example, if you're conservative or new to cryptocurrency trading, a 5x or 2x leverage would be appropriate.

An appropriate leverage amount is determined by a trader's expertise, risk tolerance, and comfort level while trading in cryptocurrency markets. Novice traders should always use caution as they learn how to trade and gain expertise.

5. Initial & Maintenance Margin

The initial margin represents the percentage of a position’s value that must be deposited by the investor before opening a position. The initial margin is directly related to the leverage applied to a position. For example, if you select leverage of 20x, your initial margin will be 5% of the position’s total value. With a larger opening position, the leverage available will be lower and thus, the initial margin will be larger. 

Maintenance margin is always calculated in the same way, however, it does not depend on the amount of leverage applied. Maintenance margin is based on a position at different notional value tiers. To enhance users’ trading experience, Binance only offers a maintenance margin that is less than half of the initial margin.

6. Liquidation

Liquidation is, perhaps, the scariest term in futures trading; it’s certainly one that everyone should look to avoid. In futures trading, liquidation refers to the force-selling of losing positions to prevent them from falling to negative equity. This occurs when a trader is not able to fulfill the maintenance margin requirements for a leveraged position. 

Liquidation can happen either slowly or quickly, depending on the amount of leverage used in a trade. For example, with lower amounts of leverage, liquidation won’t happen as soon as a minor correction occurs in the market. In contrast, higher amounts of leverage can deplete traders’ initial investment with little to no effort. 

Avoiding liquidation is only possible when we know what causes it. Find out how to reduce your chances of liquidation in this article.

7. Insurance Funds

Insurance funds are safety nets that protect traders from adverse losses, where in some cases, traders may lose more than what they have. Insurance funds are used to prevent “socialized losses,” a situation in which the profits of profitable traders are used to cover the losses of insolvent traders. 

With a well-capitalized insurance fund, traders need not worry about socialized losses, as the exchange will be responsible for the deficit. Binance operates multiple insurance funds to ensure that losses are sufficiently covered in extreme volume spikes. Binance uses insurance funds to take over bankrupt positions while offloading them into the market at a calculated pace. 

To learn more about the specific rules of the Insurance Funds, an in-depth article on them can be found here.

Final Thoughts

As you could probably tell by now, trading futures without a foundational understanding of these seven basic terms could be costly and perhaps foolish. Futures trading is complex and can be incredibly risky, which is reason enough for traders to understand how each part of a trade works. By reading this article, you can now consider yourself to have a stronger understanding of how to trade, and hopefully, you can feel more comfortable with trading decisions!

At any rate, trade with extreme care, and strategize how you wish to trade. Learning how to trade responsibly doesn’t have to come from heavy losses. See what we mean by checking in with our article on responsible trading!

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