The crypto community has always been noted for its great dynamics, and the market abounds with daring beginners and innovative investment methods. Contract trading, in particular, has remained one of the most popular choices of crypto investment. Despite its popularity, contract trading has also been heavily criticized for its high risks, difficult operations, low profits, and significant liquidation risks, which have deterred many beginners. However, such criticisms are too harsh. Buying contracts is a zero-sum game where profits earned by some are based on the losses of others. Furthermore, in addition to the relevant risks, contract trading can also be a store of value. In contract trading, investors could go long when market conditions are favorable and go short when the market is sluggish. In a bear market, contract trading could act as a stabilizer and help you preserve the original value of assets.
Contract trading is not an investment with fanciful returns. Although it is not 100% perfect, we should account for the fact that financial investments are always exposed to risks, and only bank deposits could offer guaranteed returns. Some say that contract trading is not suited for beginners as they are bound to suffer losses. This is not always the case. Beginners could start from low leverage and try out the rises and falls of the crypto market while practicing their trading skills.
The little things count: the devil is in the details
A widely-accepted view about contract trading is that it is only for seasoned investors. This misconception is rooted in the belief that veterans are better at reading the market, while newbies could suffer from forced liquidation at any moment. However, the key to contract trading is in the details, such as setting the leverage rate. As long as a valid leverage rate is set, liquidation is rare even for beginners.
That said, what is the contract leverage? In a nutshell, leverage means the multiplication of your principal, which allows you to receive higher returns with a small principal. In contract trading, you are often required to set the leverage. For example, you could choose to buy/sell at 3X, which indicates a leverage rate of three times. This means that the contract amount that you buy/sell is three times higher than your principal.
Normally, an exchange offers multiple leverage options. For instance, the below picture shows that Linear Futures Contracts on CoinEx features nine different kinds of leverage: 3X, 5X, 8X, 10X, 20X, 30X, 50X, and 100X.
For example, assuming that the current BTC price stands at 10,000 USDT, you could go long if you are confident that the price will rise soon, then you can choose to go long. Suppose you’ve only got 10,000 USDT, a contract leverage of 3X would turn your 10,000 USDT into 30,000 USDT. In other words, the trading platform lent 20,000 USDT to you. As such, you could now buy 3 BTC and the returns would be three times higher. By the same token, a higher leverage rate would offer you more funds to invest.
Although CoinEx provides 9 leverage options, beginners are advised to trade with a leverage of 3X to 8X to mitigate the risk of forced liquidation.
The higher the leverage, the more likely forced liquidation will take place. For example, suppose two traders bought the same amount of the same type of contract, compared with the one with a 5X leverage, the trader with positions at a 100X leverage is much more likely to be liquidated.
Let us go through this process using formulas:
Users who choose to go long would suffer losses in a sluggish market. To reduce liquidation risks, the liquidation price should be way lower than the open price. However, Liquidation Price of Longs = Avg. Open Price/ (1 + 1/Initial Margin Rate*100% – Maintenance Margin Rate). In other words, the higher the leverage, the closer the liquidation price will get to the average open price, and the more likely liquidation will take place. On the other hand, users who choose to go short would suffer losses in a thriving market. In this case, to reduce liquidation risks, the liquidation price should be way higher than the open price. According to the formula for shorts, Liquidation Price = Avg. Open Price/ (1 - 1/Initial Margin Rate*100% + Maintenance Margin Rate), the higher the leverage, the closer the liquidation price will get to the average open price, and the more likely liquidation will take place.
Visit the CoinEx Help Center for more details on formulas:
https://support.coinex.com/hc/en-us/articles/360035659774-Trigger-of-Forced-Liquidation
A tip for beginners: low margin & low leverage
In the contract market, newbies should be careful with two settings: margin and leverage. To be more specific, there are four different combinations: high margin & high leverage; high margin & low leverage; low margin & low leverage; and low margin & high leverage.
For beginners, high margin & low leverage and low margin & low leverage are both good choices. Although the combination of low margin & low leverage offers limited returns, it is often the most preferred leverage choice among beginners. These two combinations could significantly reduce liquidation risks and provide newbies with more space for operation.
In investment, all changes essentially follow the same pattern. Therefore, only prudent decisions will help you avoid frequent liquidation. This applies to all kinds of investments. At the end of the day, contract trading is a match between different trading strategies. You could improve your trading skills through practice, and a carefully-selected leverage rate will allow you to mitigate the relevant risks. In the meantime, the appropriate use of Take-Profit & Stop-Loss could also prevent losses arising from delayed operations. For beginners, clear market insights and a trading approach are vital to success in the contract market.
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