Everything You Need to Know About Derivatives Trading

What Is Derivatives Trading?

Derivatives trading involves an agreement between two parties to buy or sell a specific asset at a predetermined price and quantity at a set time in the future. In the context of cryptocurrency, derivatives trading specifically refers to trading contracts based on crypto-assets, such as expiring futures or perpetual futures.

Traders can profit from rising cryptocurrency prices by purchasing contracts (referred to as going "long") and from falling prices by selling contracts (referred to as going "short").

Types of Orders and When to Use Them

In derivatives trading, there are two important positions: long (bullish) and short (bearish).

When opening and closing positions, the buying and selling directions are combined in specific ways.

Opening a position means: 'Buy' to open a long position and 'sell' to open a short position.

Closing a position means: 'Sell' to close a long position and 'buy' to close a short position.

If you do not yet have a position and believe the value of an underlying token will rise, you can choose to 'buy' and open a long position. Once you have a long position, if you believe the value of the underlying token will fall, you can sell to close the long position.

Common Fields When Placing an Order

Trading Products: Perpetual and Expiring Futures

Perpetual futures are automatically renewed before they expire, allowing traders to maintain positions indefinitely without worrying about contract expiration dates. These contracts are popular for their flexibility and continuous availability.

Expiring futures, on the other hand, have a predetermined settlement period, such as this week, next week, this month, this quarter, or the second quarter of the year. These contracts require traders to close or roll over their positions before the expiration date.

Contract Units: Crypto-Margin and U-Margin

Crypto-margin contracts, also known as inverse contracts, have prices expressed in USD, but the collateral currency and the currency in which profit and loss are calculated is a cryptocurrency such as BTC or ETH. To participate in these types of contracts, you must own the respective underlying cryptocurrency. For example, in a BTC-margin perpetual future, you must deposit BTC as collateral.

U-margin contracts, also called futures contracts, have prices expressed in USDT, and the collateral currency and the currency in which profit and loss are calculated is USDT. You only need to hold USDT to trade various types of contracts, making it more accessible for traders who prefer stablecoin-denominated trading.

Position Mode: Cross-Margin and Isolated Margin

In cross-margin mode, your entire available account balance is used as margin for your position. This allows for more efficient capital utilization but also means that a significant loss could affect your ability to maintain other positions.

In isolated margin mode, the margin that is locked in when placing an initial order represents the maximum loss for that specific position. This approach provides better risk management by limiting potential losses to the margin allocated to each position.

Direction

When placing an order, you must specify the direction of your position: opening a long position or opening a short position. The direction determines whether you are betting on price increases (long) or decreases (short).

Leverage

Leverage allows traders to control larger positions with a smaller amount of capital. The higher the leverage ratio, the greater the potential return, but also the greater the risk. It is important to use leverage carefully, as it can amplify both gains and losses significantly.

Order Type

A limit order allows the user to set the quantity of orders and the highest acceptable purchase price or the lowest acceptable selling price. When the market price matches what you have set, the system executes the transaction at the best price within the price range you specified.

A market order means the user immediately buys or sells at the best price currently available in the market, ensuring the transaction is completed quickly. This type of order is useful when speed is more important than price precision.

Amount

When placing an order, you can choose to express the amount in contract units, the current token, or USDT. If there is not enough USDT in your trading account, you cannot place the order. You can still place the order by adjusting the leverage or depositing more USDT into your trading account to meet the margin requirements.

FAQ

What is derivatives trading? What are the main types of derivatives?

Derivatives trading involves financial contracts based on underlying assets like crypto prices. Main types include futures, options, and swaps, enabling hedging, speculation, and leveraged trading with higher capital efficiency.

What are the differences between futures, options, swaps, and forward contracts?

Futures are standardized contracts traded on exchanges with daily settlement. Options grant the right to buy or sell at a set price. Swaps involve exchanging cash flows or assets between parties. Forward contracts are customized, over-the-counter agreements between two parties for future delivery.

How to start derivatives trading? What conditions and capital requirements are needed?

To begin derivatives trading, open an account with a qualified broker and deposit minimum capital. Meet regulatory requirements, complete KYC verification, and choose your derivatives instrument. Start with small positions, understand leverage risks, and utilize demo accounts for practice before live trading.

What are the main risks in derivatives trading and how to manage them?

Main risks include market volatility, leverage amplification, and counterparty exposure. Manage risks through position sizing, stop-loss orders, hedging strategies, and portfolio diversification to control potential losses effectively.

What are the common hedging strategies in derivatives trading?

Common hedging strategies include long-short hedging, arbitrage strategies, and spread trading. Long-short hedging balances risk by taking offsetting positions. Arbitrage exploits price differences across markets. Spread strategies profit from relative price movements between related instruments.

What is the leverage effect in the derivatives market? How does it affect returns and risks?

Leverage in derivatives amplifies both potential profits and losses. With leverage, traders control larger positions with less capital, magnifying gains on favorable moves while equally magnifying losses on adverse price movements. Small price fluctuations can result in significant account impacts.

How should beginners learn and practice derivatives trading?

Beginners should start by learning fundamental concepts and terminology, practice on demo accounts risk-free, then gradually transition to live trading with small amounts. Start conservatively and increase position sizes as your skills develop.

What are the advantages and disadvantages of derivatives trading compared to spot trading?

Derivatives trading offers leverage for higher potential returns and hedging opportunities, but carries greater risk and complexity. Spot trading is straightforward and safer for beginners, though with limited profit potential. Choose based on your experience level and risk tolerance.