
Notice how the futures contract traded at a 1.5% to 4% discount between May and August. This backwardation demonstrates a lack of demand from leverage buyers. However, considering the long-lasting trend and the fact that Polkadot rallied 40% from July 26 to Aug. 12, external factors are likely in play.
The futures contract price has decoupled from spot exchanges, so traders must adjust their targets and entry levels whenever using quarterly markets.
Higher fees and price decoupling should be consideredThe core benefit of futures contracts is leverage, or the ability to trade amounts that are larger than the initial deposit (collateral or margin).
Let’s consider a scenario where an investor deposited $100 and buys (long) $2,000 USD worth of Bitcoin (BTC) futures using 20x leverage.
Even though the trading fees on derivatives contracts are usually smaller than spot markers, a hypothetical 0.05% fee applies to the $2,000 trade. Therefore, entering and exiting the position a single time will cost $4, which is equivalent to 4% of the initial deposit. That might not sound much, but such a toll weighs as the turnover increases.
Even if traders understand the additional costs and benefits of using a futures instrument, an unknown element tends to present itself only in volatile market conditions. Decoupling between the derivatives contract and the regular spot exchanges is usually caused by liquidations.
When a trader’s collateral becomes insufficient to cover the risk, the derivatives exchange has a built-in mechanism that closes the position. This liquidation mechanism might cause drastic price action and consequent decoupling from the index price.
Although these distortions will not trigger further liquidations, uninformed investors might react to price fluctuations that only happened in the derivatives contract. To be clear, the derivatives exchanges rely on external pricing sources, usually from regular spot markets, to calculate the reference index price.
There is nothing wrong with these unique processes, but all traders should consider their impact before using leverage. Price decoupling, higher fees, and liquidation impact should be analyzed when trading in futures markets.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.
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