The crypto sector is in a bull market, and frequent evidence comes from anonymous traders who post their five-, six- and seven-figure investment returns as screenshots on Crypto Twitter.
This condition creates a FOMO-like situation where everyone gets greedy. The temptation to boost potential earnings by twenty times or more is often irresistible for most novice traders.
Today, almost every cryptocurrency exchange offers leveraged trading using derivatives. To enter these markets, a trader has to first deposit collateral (margin), which is usually a stablecoin or Bitcoin (BTC). However, unlike spot (regular) trading, the trader cannot withdraw from a futures market position until it has been closed.
These instruments have benefits and can improve a trader’s outcomes. However, those who often rely on incorrect information when trading futures contracts end up with heavy losses rather than profits.
The basics of derivatives
These leveraged futures contracts are synthetic, and it is even possible to short or place a bet on the downside. Leverage is the most appealing aspect of futures contracts, but it is worth noting that these instruments have long been used in stock markets, commodities, indexes, and foreign exchange (FX).
In traditional finance, traders measure daily price change by calculating the average closing price changes. This measure is widely used in every asset class, and it’s called volatility. However, for various reasons, this metric isn’t helpful for cryptocurrencies and can harm leverage traders.
To be brief, the higher the volatility, the more often an asset price presents wild oscillations. Contrary to the expectation, moving up by 7% to 10% every day represents a low volatility indicator. This happens because the deviation from the mean is small, while random fluctuations between a negative 3% to a positive 3% present a much wider range.