How to Use Perpetual Futures in Crypto Trading

Perps allow traders to hold bullish or bearish positions in perpetuity, helping them adapt their strategies based on the market conditions. Other advantages include:

• Leverage – Traders can control larger positions with a smaller initial investment, enabling them to amplify potential gains (and losses).
• Flexibility – No expiration date means that traders can hold their positions indefinitely, which allows them additional time to let the trade play out.

Perpetual Futures vs. Traditional Futures: Key Differences

Perpetual and traditional futures both offer ways to speculate on an asset price’s direction. However, they differ in several ways:

• Expiration
• Traditional Futures have a set expiration date for the contract to settle.
• Perpetual Futures have no expiration date. This means traders can hold positions indefinitely, allowing for long-term strategies without the need to constantly roll over the contracts.
• Settlement
• Traditional Futures can be settled through physical delivery of the underlying asset (e.g., bitcoin) or, more commonly, through cash settlement based on the difference between the contract price and the spot price at expiration.
• Perpetual Futures settlements occur through a funding mechanism that ensures the contract price stays close to the spot price.
• Trading Strategies:
• Traditional Futures are often used for hedging or short-term speculation and anticipating price movements before the contract's expiration.
• Perpetual Futures are used more for long-term trading strategies. The absence of an expiration date means that traders can hold positions for extended periods to potentially capture long-term trends or profit from range-bound markets.

The Mechanics of Perpetual Futures

Funding Rate

The funding rate mechanism is a periodic payment between long and short position holders. If the perpetual futures price is above the spot price, long position holders pay the short position holders, and vice versa.

This mechanism is used to keep the price of a contract close to the spot price of the underlying asset and prevent significant divergences.

Mark Price vs. Index Price

The index price refers to the actual price of the underlying asset on a spot exchange while the mark price is calculated to determine potential liquidations and unrealized profit and loss (PnL).

Both prices are measured to help prevent market manipulation and sudden liquidations.

Long and Short Positions

Perpetual futures offer certain flexibilities that are not available to spot traders, allowing them to generate more profit based on the market conditions.

When a trader opens a long position, also known as going long, they believe and will make profits if the asset’s price increases.

On the other hand, traders open a short position, also known as going short, when they believe the price of the asset will decrease.

Trading Strategies for Perpetual Futures

Perpetual futures offer a playground for a range of trading strategies, catering to various risk appetites and market outlooks:

• Hedging – Taking the opposite side of a bet to protect against potential losses
• Example: If a trader owns Bitcoin (BTC) but is concerned about a short-term price dip, they might open a short position in a BTC perpetual futures contract to potentially offset any losses in their spot holdings if the price goes down.
• Leverage – Leverage allows traders to control larger positions with less capital.
• Trend following – Technical analysis can help identify trends and potential entry/exit points in the perpetual futures market.
• Arbitrage – If there is a price discrepancy between different exchanges, traders can purchase perpetual futures on one exchange and simultaneously sell them on another, pocketing the price difference.

Advantages and Disadvantages of Perpetual Futures

Perpetual futures allow traders to be flexible while and offer the potential for high returns. However, perps also come with unique risks.

Advantages:

• No expiration date – Traders can hold their positions for as long as they like, which could help their long-term strategies by removing market fluctuations.
• High leverage potential – Perpetual futures often come with significantly higher leverage options, which allows traders to increase their potential gains.

Disadvantages:

• Funding rates – The funding rate mechanism helps keep the price of assets in line with the spot market. These rates, paid between long and short position holders, can impact profitability, especially for those holding positions for extended periods.
• Liquidation risk – Small adverse price movement can trigger a margin call and potentially liquidate the trader, resulting in the loss of their investment.
• Complexity – Traders need more knowledge in order to trade perps as they need to understand things like funding rates and margin management, which could adversely effect their trading strategies.

Perpetual futures essentials

• Perpetual futures are a type of derivative contract without an expiry date, allowing traders to hold positions indefinitely and speculate on the price of an asset.
• Unlike traditional futures, perpetual futures are settled through a funding mechanism and are primarily used for speculation and hedging.
• While perpetual futures offer benefits like flexibility and high leverage potential, they also carry significant risks, including funding rate impacts and the possibility of liquidation.