Futures trading has grown tremendously over the past year and evidence of this is the overall increase in open positions. Open Interest is the total number of contracts outstanding and The number has grown from $ 3.9 billion to $ 21.5 billion today in six monthsThis corresponds to an increase of 450%.
Sometimes traders assume that a high or low funding rate and rising interest rates indicate a bull market., but as Cointelegraph previously stated, that’s not the case. This article takes a quick look at the funding rate and how traders interpret the metric when trading perpetual futures contracts.
The funding rate can be both a bullish and a bearish indicator
For perpetual contracts, an implicit exchange rate applies, typically calculated every eight hours to ensure that the exchange rate risk is not unbalanced. Although the open interest of buyers and sellers is the same at all times, their leverage can vary.
When those who demand more leverage for a long time pay the fee. Therefore, This situation is interpreted as bullish. The opposite is true when shorts use more leverage. cause a negative funding rate.
Whenever traders use a high level of leverage, Analysts point to cascading liquidation risks. While this is true, this situation can unfold over weeks and the deleveraging process sometimes occurs on its own. This indicator should not be used to predict local highsas the data will show.
Bull markets tend to trigger positive funding rates when buyers are overly excited. Still, this situation creates a perfect storm for short sellers as a 5% price correction will force the long positions to be liquidated with 20x leverage. These orders could put pressure on the price, cause a 10% drop, and then trigger a cascade of liquidation.
Therefore, Experts and analysts often point to inflated funding rates as the main cause of cascading liquidations when the market turns redalthough the funding rate can remain unusually high during bull runs.
Funding rate can identify local funds
Note that in February, when a local high was not being formed, the funding rate was 0.15% and above per 8 hour session. This rate equates to 3.2% per week and is a bit onerous for traders who are long positions.. Therefore, trying to measure market spikes using this metric rarely produces good results.
On the other handThe BTC lows on January 27th and February 28th occurred during times when the funding rate was low. These moments show that traders were unwilling to take advantage of longs and it shows that they lack confidence.
Low funding rates need to be considered in the context
Although this indicator can help determine whether a local soil has formed, it should by no means be used alone, as the financing quota tends to dissolve after a strong price correction.
What’s more Persistent periods of high funding will attract arbitrage traders who sell the perpetual futures while buying the monthly contracts. Therefore, this metric should be used with caution.
In order to confirm investor mistrust in opening longs, it is necessary to monitor the premium of the monthly contracts known as the base. In contrast to the perpetual contract, these fixed calendar futures do not have a financing rate. Therefore, the price will be very different from that of the regular spot exchanges.
Measurement of the difference in effort between futures and the regular spot market, A trader can measure the level of market optimism. Whenever there is excessive optimism from buyers, The 3-month futures contract trades at an annualized (base) premium of 20% or more.
By combining the indicators, the local lows of the BTC price can be determined
If, on the other hand, the indicator marks a local soil, This usually means that traders’ confidence is gaining momentum. In a scenario where the funding rate for perpetual contracts is low, There is better “confirmation” from low leverage buyers.
By combining the financing rate of perpetual contracts with the basis of monthly contracts The trader will be better able to assess the market sentiment. Like the popular “indicator of fear and greed”, Traders should buy when others are in disbelief.
This scenario typically occurs when the funding rate is below 0.05% for 8 hours and the 3 month futures base hits a bottom.as indicated in the graphic above.
The points of view and opinions expressed here are exclusively those of author and do not necessarily reflect the views of Cointelegraph. All investments and business are associated with risks. You need to do your own research when making a decision.