Sometimes a market crash is enough for the crypto space to be full of news headlines pointing to the millions of dollars lost in liquidation. According to the Coinglass Liquidation Data, “70,170 traders were liquidated, with the amount of the total liquidation sitting at $127.95 million!”
Follow us in this episode of the “Do You Speak Crypto?” series to learn about common futures market terms that will help you to understand the reason behind these massive losses.
An agreement between you and another party to sell or buy a specific underlying asset at a predefined price and date in the future. With futures contracts, you don’t need to buy the actual asset and can simply speculate on its future price.
Bitcoin Futures contracts are an example of futures contracts whose value is broadly dependent on Bitcoin’s spot price.
The delivery date, expiration date, or maturity date, is the time that you’ve specified in your futures contract for your positions to get settled. Some commodities require physical delivery of the underlying asset and the place for the delivery is usually specified by the broker.
It’s worth mentioning that a Perpetual Contract is a kind of futures contract that doesn’t have a delivery date.
You open a long position when you expect the price of your desired asset to increase in the future.
Let’s say Bitcoin is changing hands at $30k and you believe that its price would increase in a couple of months. You enter an agreement with another trader, agreeing to buy 1 Bitcoin at $30k within 2 months.
Here, you are betting against the future price of Bitcoin without actually buying one. In the best-case scenario, Bitcoin’s price will increase in the next 2 months and you can buy 1 Bitcoin below the market price.
The futures market allows you to benefit from both market directions. Let’s consider the seller in the previous example.
The seller has agreed to sell their Bitcoin because they believe the price will drop within the next couple of months. In this way, they can sell their Bitcoin above the market price and make profits.
Margin trading allows you to get more exposure to the markets by borrowing capital from your broker or other traders. In other words, you can open your desired position by just paying a portion of the required amount.
The initial margin is the required amount you have to pay to be able to open a position. This amount depends on the leverage rate you choose to have.
Leverage refers to the amount of capital you are willing to borrow. For example, you want to open a $50k position. You opt for a 50x leverage which allows you to borrow up to 50 times your initial investment. In other words, you just need to pay $1k to open your $50k position.
To keep your leveraged position open, each trading platform asks you to keep a specific amount of funds in your trading account. They use maintenance margin as collateral to cover any potential losses caused by future price fluctuations.
When your account value falls below the required amount, you’ll get a margin call from your broker to add additional funds to your account to bring it back up to the level.
Normally, the broker will give you some time to meet the margin requirements. If you fail to increase your account value, the broker can sell and liquidate part or all of your assets without your permission to cover any loss.
This situation is what we call liquidation which may cost you all your money. As a rule of thumb, never invest more than you can afford to lose and always have proper risk management techniques in place.
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