Perpetual Futures Contracts: A Simple Guide for Beginners

If you’ve heard about futures contracts, you might have come across the term "perpetual futures contracts."

These are making waves in the crypto trading world, and for good reason.

They offer a flexible way to trade that traditional futures contracts just can’t match.

Whether you're a newbie or an experienced trader, understanding perpetual futures can really set you apart.

Wondering what they are and how they work? Let’s dive in and uncover the details!

What Are Futures Contracts?

Before we talk about perpetual futures, let’s first understand what a futures contract is.

A futures contract is a type of derivative. Derivatives are financial instruments whose value is derived from an underlying asset, such as commodities, currencies, or cryptocurrencies.

Within the derivatives class, a futures contract is a legal agreement to buy or sell an asset at a set price on a specific date in the future.

People use them to protect themselves from price changes or to bet on where the price will go.

Example:

• Imagine you make a deal to buy a contract worth 1 Bitcoin for $50,000 three months from now. No matter what the price of Bitcoin is in three months, you will buy 1 Bitcoin for $50,000 when the contract settles. This kind of deal is called a futures contract.

Key Features of Futures Contracts

1. Expiry Date: Futures contracts have a set end date. This means there is a specific day when the deal must be completed, and the buyer and seller must fulfill their agreement.
2. Standardization: These contracts are standardized, which means they all follow the same rules. For example, each contract specifies the exact amount of the asset being traded and the date when the contract expires.
3. Leverage: Futures contracts often allow traders to use leverage. Essentially, you can trade multiples of your collateral without the need to borrow and incur interest payments. This free leverage can amplify your potential profits (but also your potential losses).

Transition to Perpetual Futures Contracts

Now that we understand futures contracts, let’s move on to perpetual futures contracts.

A perpetual futures contract is similar to a traditional futures contract but with one key difference: it doesn’t have an expiry date.

This means you can keep your trade open as long as you want, whether you're betting that the price will go up or down.

You just need to make sure you have enough money in your account to cover the trade.

Key Features of Perpetual Futures Contracts

1. No Expiry Date: You can keep your trade open indefinitely.
2. Leverage: You can trade multiples of your collateral without borrowing money, which can increase your potential profits or losses.
3. Funding Rates: To keep the contract price close to the actual market price of the asset, traders make regular payments to each other. These payments happen at set intervals, like every 8 hours.

How Do Perpetual Futures Contracts Work?

Perpetual futures contracts work similarly to regular futures contracts but with some unique twists:

Trading with Leverage

Leverage lets you trade a larger amount of money than you actually have. It's like amplifying your buying or selling power.

For example, if you have $100 and use 10x leverage, it means you can trade with $1,000.

Example:

• You use $100 to open a $1,000 position in Bitcoin with 10x leverage.
• If Bitcoin’s price increases by 10%, your position value becomes $1,100, giving you a $100 profit.
• If Bitcoin’s price decreases by 10%, your position value becomes $900, resulting in a $100 loss (your entire initial investment).

Understanding Funding Rates

Funding rates are small payments that traders make to each other to keep the contract price close to the actual market price of the cryptocurrency. These payments usually happen every 8 hours.

• Positive Funding Rate: If the rate is positive, traders who are betting the price will go up (long positions) pay those betting the price will go down (short positions).
• Negative Funding Rate: If the rate is negative, short positions pay long positions.

Example:

• If the funding rate is 0.01%, and you hold a long position worth $1,000, you will pay $0.10 every 8 hours to short position holders.

Margin and Liquidation

When you trade with leverage, you need to keep a minimum amount of money in your account, called the margin.

If your account balance falls below this amount, your trade will be automatically closed, or "liquidated," to prevent further losses.

Example:

• You have a $1,000 position with a $100 margin requirement.
• If the market moves against you and your account balance drops below $100, your position will be liquidated to cover the losses.

Why Trade Perpetual Futures Contracts?

Perpetual futures contracts offer several benefits for traders:

1. Flexibility: Since there’s no expiry date, you can hold positions as long as you want.
2. Leverage: This allows you to amplify your potential gains with a smaller initial investment without borrowing costs.
3. Hedging: You can protect your investment portfolio against adverse price movements.

Risks of Trading Perpetual Futures Contracts

While perpetual futures contracts offer opportunities, they also come with significant risks:

1. Risk of Liquidation: Using leverage increases the chance of your position being liquidated.
2. Funding Rate Costs: Regular payments can eat into your profits.
3. Market Volatility: Sudden price changes can lead to large losses.

How to Get Started with Perpetual Futures Contracts

Here’s a step-by-step guide to help you start trading perpetual futures contracts:

1. Choose a Trading Platform: Popular platforms like Binance, Bybit, and BitMEX offer perpetual futures trading.
2. Create an Account: Sign up and complete any necessary verification processes.
3. Deposit Funds: Add money to your account to start trading.
4. Select Your Leverage: Decide how much leverage you want to use. Remember, higher leverage means higher risk.
5. Place Your Trade: Choose whether to bet on the price going up (long) or down (short) based on your market prediction.
6. Set Stop-Loss and Take-Profit Orders: Protect your investment by setting automatic orders to close your position at certain price levels.

Example of a Perpetual Futures Trade

Let’s walk through a detailed example to illustrate how a perpetual futures trade works:

Scenario:

• You believe Bitcoin’s price will rise.
• You deposit $500 into your trading account.
• You choose 5x leverage, allowing you to open a $2,500 position.

Trade Execution:

1. Open Position: You go long on Bitcoin at $50,000.
2. Price Movement: Bitcoin’s price rises to $55,000.
3. Profit Calculation: Your position value increases to $2,750 ($2,500 + $250 profit).
4. Close Position: You close your position and realize a $250 profit, which is a 50% return on your initial $500 investment.

Conclusion

Perpetual futures contracts are a powerful tool in the crypto trading world, offering flexibility and the potential for amplified gains.

However, they also come with significant risks, especially when trading with leverage.

By understanding how they work and implementing risk management strategies, you can navigate the world of perpetual futures trading with confidence.

Happy trading, and may your crypto journey be profitable and exciting!