What is Perpetual Futures Trading?

Perpetual trading has gained significant popularity among traders due to its flexibility and potential for profit. This type of trading allows you to capitalize on both bullish and bearish markets. Leveraging can further amplify your gains, but it’s important to understand the associated risks. Find out more about perpetual futures trading in the following article.

Article Summary

• 📜 Perpetual futures is a type of derivative that allows traders to speculate on the price movement of an underlying asset, in this case cryptocurrency, without any expiration date or deadline.
• 💸 With perpetual trading, traders can profit both when the market is bullish by opening a long position, or when the market is bearish by opening a short position.
• 🤑 Perpetual trading supports leverage, which can amplify a trader’s profit potential. But on the one hand, leverage also comes with a high risk of liquidation.

What is a Perpetual Trading in Futures?

To understand perpetual trading, we must first grasp the concept of derivatives. It is the underlying principle of perpetual trading. Essentially, derivatives are financial products whose value is derived from another asset, in this case, crypto assets.

One form of derivative product is a futures contract. In a futures contract, each contract has a specific expiration date and a predetermined price. Additionally, there are also perpetual contracts or perpetual futures. Perpetual futures is a derivative asset that tracks the price of its underlying cryptocurrency without an expiration date. This means traders can hold their positions indefinitely. Through perpetual futures, traders can gain exposure to the price movements of their assets without having to own them.

You can trade perpetual futures through centralized exchanges (CEX) like Pintu or decentralized exchanges (DEX) like dYdX.

Learn more about how decentralized perpetual trading works in the following article.

How Perpetual Futures Works

To determine the contract’s price, perpetual futures use an index price derived from the prices of various exchanges. A mechanism known as the funding rate is used to keep the perpetual futures price aligned with the spot price. We’ll discuss the funding rate in more detail later.

Unlike spot markets, where traders can only profit from the price increases, perpetual markets allow traders to profit whether the market goes up or down. In other words, perpetual trading offers the potential for profit in both bullish and bearish markets.

There are two primary positions in perpetual trading:

• Long Position: Traders open a long position when they expect the crypto price to rise. Once the price increases, they can close the position to realize a profit.
• Short Position: A short position is the opposite. Traders borrow and sell crypto from the exchange, expecting the price to drop. They then repurchase the cryptocurrency at a lower price and return it to the exchange, keeping the difference as profit.

Elements in the Perpetual Trading

Some of the mechanisms listed below are essential elements to ensure perpetual trading works.

Perpetual Funding Rate

As previously mentioned, the funding rate is designed to align the index price of perpetual futures contracts with the spot market price. It’s a fee exchanged between long and short traders, depending on market movements. This fee is usually applied every eight hours.

The primary purpose of the funding rate is to prevent significant price discrepancies between perpetual futures and the underlying spot market. When the perpetual futures price deviates substantially from the spot price, the funding rate comes into play. It incentivizes traders to take positions that counteract the current market trend, thereby reducing the price gap.

The funding rate can be either positive or negative.

• A positive funding rate occurs when the perpetual trades above the spot price. In this case, long position holders pay a fee for short positions.
• A negative funding rate occurs when the perpetual trades below the spot price. Here, short position holders pay a fee to long position holders.

Funding rates can help you execute perpetual trades more optimally. Learn how here.

Leverage

Leverage is a trading feature that allows traders to borrow funds from the exchange to trade with a larger amount of capital. With leverage, users can increase their purchasing power, enabling them to trade with a larger amount of capital than what they actually have in their wallet.

Typically, leverage levels are described with ratios such as 1:5 (5x), 1:10 (10x), 1:20 (20x). This ratio indicates how many times the user’s initial capital will be multiplied. For instance, if you have $100 but want to trade $500 worth of BTC, a 5x leverage would allow your $100 to have a purchasing power of $500.

The advantage of using leverage is that it amplifies potential profits as your trading capital increases. Additionally, users can also improve their capital efficiency. For instance, instead of buying $100 worth of BTC, they can use $10 with 10x leverage. The remaining capital can be allocated to opening new positions or used in DeFi platforms.

While leverage can significantly boost potential profits, it also comes with heightened risks. Higher leverage levels mean a lower tolerance for price fluctuations. Additionally, there’s the risk of liquidation, where your position is automatically closed if it moves against you, potentially resulting in a total loss of your investment.

Margin

Margin is the amount of funds that an investor must deposit with an exchange to open a perpetual trading position. It serves as collateral for the exchange against potential trader losses. For example, to open a $1,000 position with an initial margin requirement of 20% (5x leverage), you would need to deposit $200.

In addition to opening a position, a margin is also required to maintain an open position, known as the maintenance margin. The minimum margin balance must always be maintained in your account to keep the position open.

The position will be liquidated if the margin balance falls below the maintenance margin. For instance, to maintain a $1,000 position with a maintenance margin requirement of 5%, $50 must be held as a margin.

To prevent liquidation, the exchange will send a margin call to the trader. If a trader's account receives a margin call, they cannot open new positions or place new orders until they add more margin to their futures account.

Liquidation

Liquidation is the most significant risk associated with perpetual trading. It occurs when a trader is unable to maintain the required maintenance margin. Once liquidated, the entire balance in the trader’s futures account will be lost.

The primary factor influencing liquidation is the level of leverage used. Higher leverage levels result in a lower tolerance for price fluctuations. In simpler terms, the higher the leverage, the greater the risk of your position being forcibly closed.

For instance, if you open a $500 BTC/USDT position using 10x leverage, a 10% drop in the price of BTC would result in a $50 loss, wiping out your initial investment. The exchange would then liquidate your position to prevent further losses

The Advantages and Disadvantages of Perpetual Trading

Advantages of Perpetual Trading:

• ⌛ No expiration date. This allows traders to hold their positions for an extended period.
• 💰 Profit in bullish and bearish markets. Perpetual trading enables traders to profit regardless of whether the market trends up or down.
• 🏦 Deeper liquidity. In some cases, perpetual markets can have deeper liquidity compared to spot markets.
• 💡Higher potential profits and increased capital efficiency. Leverage allows traders to amplify their potential gains and use their capital better.

Disadvantages of Perpetual Trading:

• ☠️ Higher risk of liquidation. The use of leverage increases the risk of losing your entire investment.
• 💲 Funding rate costs. In certain market conditions, funding rates can be costly and erode profits.
• 🔍 Complex risk management. Managing margin requirements and the risk of liquidation requires careful risk management.

The most important factor in perpetual trading is risk management. Learn how to do that here.

Conclusion

Perpetual trading offers opportunities for traders interested in speculating on the future price of crypto assets without expiration dates. With leverage, perpetual trading also presents the potential for higher profits than spot trading.

However, perpetual trading also carries higher risks compared to spot trading. Traders must be more careful in managing leverage usage, margin requirements, and risk management strategies. If miscalculated, a trader’s futures account can be liquidated, resulting in the loss of all invested capital. Therefore, in-depth research, understanding how the system works, and having a clear risk management plan before engaging in perpetual trading are essential.

How to Buy Crypto on Pintu

Looking to invest in crypto assets? No worries, you can safely and conveniently purchase a wide range of cryptocurrencies such as BTC, ETH, SOL, and others safely and easily at Pintu. Pintu diligently evaluates all its crypto assets, highlighting the significance of being cautious.

Pintu is also compatible with popular wallets such as Metamask to facilitate your transactions. Download Pintu app on Play Store and App Store! Your security is guaranteed because Pintu is regulated and supervised by Bappebti and Kominfo.

Aside from buying and trading crypto assets, you can expand your knowledge about cryptocurrencies through various Pintu Academy articles. Updated weekly, all Pintu Academy articles are made for knowledge and educational purposes, not as financial advice.