Funding Rate | Funding Rate Index Analysis in Futures Trading
If you’ve invested in the digital currency market, you’ve probably seen the Funding rate index in cryptocurrencies to date. This index, which belongs to the futures market, can be a criterion for detecting price trends, recognizing market sentiment, and formulating and modifying a trading plan. Therefore, a correct understanding and power of fundraising analysis can help us earn money from futures trading.
What is Futures Trading?
In the future, the parties predict the exchange of asset prices in the coming days. The time intervals of these transactions may be short-term or long-term. If, at the time of the transaction maturity, the value of the cryptocurrency is less than the expected price, the buyer will pay the difference to the other party. Also, if at the contract’s maturity, the chart shows a price moment higher than the expected figure, the seller must pay the transaction damages.
The difference between traditional futures and regular trades
Futures are traded in two forms: traditional (Perpetual futures) and permanent (Traditional futures). In traditional futures trades, the expiration date for the trade will be specified. After the expiration date, the settlement is made, and the profit and loss of the parties to the transaction are determined.
There is no expiration date on expired trades. As a result, by creating a gap between the instantaneous value of the asset and the forecasted price, traders’ profit margins may constantly change and become significant. Exchange offices use a funding rate indicator to prevent crises and control the situation.
What is Funding Rate?
Funding Rate The ratio of Ramzars’ current price to the forecast rate. When a digital currency’s price is higher than the predicted value in a permanent open futures trade, the funding rate will be positive. If the cryptocurrency is worth less than the set price, the funding rate will be negative.
This parameter is positive, the seller must pay an amount to the buyer. If the index is negative, the buyer must accept responsibility for paying the difference between the contract price and the current rate.
The main use of this index is to converge the prices set in futures trading and the asset’s real value. The higher the funding rate, the more traders will close their trading positions, thus again reducing the gap between the forecast figures and the current price. As a result, the Funding Rate will be reduced again.
This index is constantly updated in different exchanges. For example, Binance Exchange updates its funding rate every 8 hours. The more accurate this parameter is, the more accurate a picture of traders’ potential profits and losses will be. When the investor feels that more losses are on the way, he will close the deal so as not to incur heavy financial losses.
Funding rate analysis
If the contract price is higher than the current asset price, the funding rate index will be negative. In this case, traders who have opened long trades may be persuaded to close. On the other hand, if this parameter is positive, traders will be inclined to open long trades, and currency cryptocurrencies in short positions are likely to suffer financial losses.
When traders use Leverage to close a deal, paying attention to the funding rate is much more important. The profit and loss from the difference between the actual price and the expected value will be multiplied. Therefore, traders who open such positions must be proficient in fundraising analysis.
In general, it can be said that according to the Funding Rate, trading positions can be managed. This index can also estimate the willingness of traders to open short-term or long-term trades.
Correlation of funding rate with market sentiment
The funding rate is closely related to the general trend of prices and sentiment in the market, but it is not a direct relationship. The chart below shows the changes in the price and fundraising rate of Bitcoin over 30 days.
As seen in the chart above, the price increase in January 2020 has led to a doubling of the bitcoin funding rate. As the index doubled, traders were encouraged to open regular futures trades, thus helping to raise the BTC price.
Comparison of Bitcoin fundraising changes in popular exchanges
In the chart below, you can see the changes in the Funding Rate of seven famous exchanges. Exchanges are trying to stabilize the chart of changes in this index. The high volatility of this index will have a huge impact on traders’ profits and losses.
Bainance Exchange is one of the best trading platforms in the field of control of this index. This exchange was able to control the trend of changes in bitcoin fundraising rates within a certain range. As a result, the profits and losses of futures market participants are largely controlled.
How do money changers control the Funding Rate?
One of the strategies that exchanges use to control the fund rate is arbitrage in the cash and futures markets. The digital currency market is constantly active, and there is always an arbitrage opportunity.
Arbitrage means buying an asset and selling it quickly. The price difference between the two platforms or the market is used in this transaction. Profit in arbitrage trades is only achieved due to the price difference between the two trading platforms at a time.
Many arbitrage trades are made in futures markets. In this type of arbitrage, there is a discrepancy between the asset’s current price and the price set in futures trading.
In the first case, the price in the futures market is higher than in the cash market. The price gap is such that the transaction will be economically justified. So the trader buys the currency code in the instant market in cash and sells a futures trade simultaneously. The trader’s profit will equal the difference between the cash market price and futures.
In a situation where the cash market price is higher than the asset’s value in the futures market, the trader simultaneously makes two trades in the futures market. The settlement date of the two transactions will be different. Otherwise, the investor will create a pre-purchase asset to sell the cryptocurrencies shortly.
With the help of arbitrage trades, current price and futures bring an asset closer together. In this way, we will see a decrease in the funding rate. In exchanges where traders are free to conduct more arbitrage, the volatility of this index will be less.
Conclusion
The funding rate is the ratio of the current price of digital currency to the value predicted in futures trading. With the help of this index, traders understand the market situation and manage their trades. An increase in fundraising indicates a difference between futures and cash markets, leading to huge gains and losses. For this reason, money changers are trying to warn traders about possible losses by updating this index.
