What is futures trading?

Galimzyan
ARTICLE BY
Galimzyan
10 MIN READ
Trading
14 July 2023
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What is a futures?

In everyday life, when you buy something, the transaction between you and the seller of the commodity happens the second you buy it. Futures work differently, instead of settling now, we agree to transact at a certain time in the future at a certain price.

Futures market participants trade contracts that reflect the value of the underlying asset. When purchasing a futures contract, the user does not directly purchase the asset itself. Instead, he becomes the holder of a contract that obligates him to buy or sell the underlying asset in the future. Therefore, owning a futures contract does not provide additional economic opportunities such as voting or staking.

So, a futures (futures contract) is a contract to buy or sell at a specific price, at a set date in the future.

How did futures come into being?

Although futures are now traded online on modern and sophisticated platforms, the concept dates back to the distant past. Early mentions of this tool indicate that people have always tried to find ways to make their transactions and their lives more efficient.

How did futures come into being?

The first description of an instrument that differs little from futures trading as we know it today dates back to 1750 BC and was recorded in the Code of Hammurabi, one of the oldest deciphered documents in the world, found in ancient Mesopotamia. Part of the code stated that goods were to be delivered at an agreed upon price at a date in the future, subject to a written contract. At the time, futures contracts were exchanged in ancient Mesopotamian temples.

futures

References to early futures trading can be found in the writings of Aristotle, which describes the story of Thales, a philosopher who made "agreements" with olive mill owners to give them his money and use their mills in the future, based on his prediction that the harvest was about to get stronger. 

Who uses futures?

The first "modern" futures exchange, the Dojima Rice Exchange, was established in Japan back in 1697. There, speculators collected rice futures contracts and traded them based on the expected future value of rice. Why was the Dojima Rice Exchange so important? Because Japanese leaders and samurai were paid in rice.

Who uses futures?

  1. Producers and consumers of the underlying commodity. For example, if you grow grain, you can hedge against a drop in the price of your product in the future. By selling grain futures at a certain price at a certain date in the future, even if the price drops sharply due to a high harvest, you will still get a good price. If you produce flour, you can fix the price of your raw material by buying grain futures. In this way, even if prices rise significantly due to low yields, the raw material will be bought at a good price and your cost of production will not increase.
  2. Speculators who work with the movement of futures prices. Another group that buys and sells futures are speculators such as intraday traders, portfolio managers, hedge funds and other institutions.  Futures are highly leveraged, which means that a trader only has to put up a portion of the full contract as margin, but can profit from fluctuations in the price of the entire contract. This allows the trader to control a large position with a small amount of capital. 
  3. Hedging with futures. In addition, futures markets allow traders to take short positions, taking profits if the price of the asset falls. While you can sell traditional stocks or cryptocurrency short, you must first borrow the underlying asset and pay interest, which is not the case with futures. Thus, futures drastically reduce the costs of short selling.

For example, you bought Bitcoin as a long-term investment, in the moment the price starts to fall and your portfolio suffers losses. With futures, you can open the opposite position, equalizing the balance of your portfolio. The loss from the portfolio, is offset by the profit of the short futures position.

This is why speculators prefer to use futures trading.

cryptocurrency futures

How are cryptocurrency futures structured?

The instrument resembles stock indices or commodity futures contracts - where an investor can assume the risks of the cryptocurrency's value. According to the contract, the trader uses cash settlement, but does not trade cryptocurrency in the literal sense.

Trading contracts represent the value equated to a specific cryptocurrency. And, as we said, when trading futures, you don't own the asset itself.

With futures contracts, you can capitalize on price volatility. Futures allow you to participate in the movement of cryptocurrency, regardless of whether prices are rising or falling. In other words, they can be used to speculate on the price of cryptocurrency instead of buying the underlying asset.

How to trade futures?

How to trade futures?

The complexities of cryptocurrency futures trading require diligent study of the basics, including the mechanisms that influence each trade. To become experts in cryptocurrency futures trading, it is crucial for potential traders to familiarize themselves with such basic market concepts as leverage, margin, and funding rate. Only after gaining this knowledge, you can approach the status of a professional trader.

If the value of an asset is expected to rise, you buy a futures contract, opening a long position. If the value of the asset is expected to fall, you sell it, opening a short position. Whether it will be a profit or a loss will depend on the result of your forecast.

Today, exchanges offer a wide range of cryptocurrency derivatives, providing investors and traders with many trading opportunities.

Two lines of futures products are available to users:

USD-margined futures contracts: support perpetual and deliverable contracts with leverage and settlement in USDT and BUSD.

Coin-margined futures contracts: support open-ended and deliverable contracts with leverage and settlement in cryptocurrency.

If you're interested in futures trading, explore the pros and cons of the different types of futures contracts.

Difference between spot and futures

Futures from spot mainly differ in the actual delivery of the crypto. While futures contracts are settled in the future, in the spot market, the transaction is made directly in the course of trading.

Pros and cons of futures trading

Futures trading, like any profitable endeavor, is characterized by a number of advantages and disadvantages. Below are the main pros and cons of trading in these instruments.

Pros of futures trading

  • Cryptocurrency futures trading allows you to play against the market. You can profit both when the value of cryptoassets rises and when they fall.   
  • Cryptocurrency futures allow you to leverage your capital. This is useful as traders get weighty access to the asset by paying only a fraction of its value. Therefore, leverage is considered to be the most attractive feature of futures trading.
  • Hedging Opportunity. Futures are an excellent opportunity to hedge your portfolio.

Cons of futures trading

  • Volatility. High volatility is not necessarily good for traders. It is not always possible to accurately determine market movements.   
  • High risk. Leverage makes cryptocurrency futures one of the riskiest trading instruments. Beginning traders should minimize futures trading and develop a solid risk management strategy.
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