Binance Spot vs. Futures: Risk Management
What makes futures trading different from spot trading in terms of a potential risk and reward?
Binance supports both Spot trading and Futures trading. However, they have inherent risks that traders must maneuver to increase their profit margins or just escape losses.
Let’s look at what futures trading is and how different it is from the spot trading to get everyone on board.
Spot trading is simple, different, and straight forward. For instance, heading to Binance and depositing fiat to buy Ethereum or using Litecoin to buy Bitcoin.
In futures trading, investors speculate on the future price of a cryptocurrency like Bitcoin. What makes Futures trading different from Spot trading is the level of risk, potential profit, and some technical aspects like leverage, funding rate, and liquidation price. Let’s assume you want to buy some BTC (current price is 10,700 USDT) with a 100 USDT balance.
In the spot market, you can purchase 0.0093 BTC (100 USDT/10,700 USDT) while in the Binance futures market, with 100 USDT on your balance and with a maximum leverage of 125X, with 12,500 USDT you can buy 1.168 BTC (12,500 USDT/10,700 USDT). In futures trading, the losses and profits are equally amplified by the leverage. As such, futures and spot trading risk management profiles are different.
⚖️ Risk and Reward in Futures Trading
The bigger is leverage - the closer is a liquidation price to an open price. In the example below, a liquidation price for a 1 BTC long position with a 125x leverage at 10700 USDT is 10642 USDT. Such a narrow gap creates a risky situation in which your position can be automatically closed due to insufficient margin balance as Bitcoin's price is extremely volatile.
A $50-$300 price swing in a matter of just a few seconds is not a rare event. Not only must you be right about predicting the market direction but the right moment at which it will start rising so that your 125x long position remains open.
🤔 How to manage your risks when trading futures on Binance?
Whether you’re into Spot trading or Futures trading, the end goal is one; make a profit even when the market is in a downward spiral through short-selling. Therefore, how you manage the risks determines how far you fall from your target.
Make sure you are utilizing risk management instruments like Stop-Loss and not going “all-in” in one trade. Use a built-in Binance calculator to get a required initial margin for the desired trade size and a liquidation price.
- Initial margin - a minimum balance to cover a leveraged position.
- Liquidation price - a price at which a futures contract will be automatically closed If a trader fails to fulfill the maintenance requirement due to insufficient margin to cover a loss.
🤩 Don’t blindly take positions
In futures trading, a trader can take either a short or a long position. A short position means that trader is betting on a falling market or they hedge against it, while a long position is a call to open a position in a rising market with interest for the price to go up.
A trader’s position decision should be backed up by strong technical and fundamental analysis. Here you can find some relevant articles to empower yourself with new knowledge about the cryptocurrency market analysis.
📈 Maximize the use of different order types
Binance’s futures trading platform presents different order types to ensure a smooth trading experience.
Limit orders allow traders to short or long at a specified price or better. A market order uses the immediate market price, and a stop-limit order is filled after a trader-specified price has been reached.
Note: market makers pay fewer fees for providing liquidity (0.02%) while takers pay more for removing liquidity (0.04%).
💡 Be cautious with leverage
Binance futures has a leverage of up to 125X. Higher leverage means more profits, but also more risks and tighter liquidation price to an open price. Therefore, treat the leverage ground carefully.
For example, if you take a long spot position worth 1 BTC at the price of $10,700 and the price dips by 20 percent to $8,560, you incur a loss of $2,140. With the leverage of 125X, you only need 85.60 USDT as the initial margin to enter a trade of 1 BTC. Automatic liquidation at $10,642 prevents the loss to be more than the trader can handle by automatically closing the position.
📌 Plan your opening of a short or long position on Binance Futures
- Check the accuracy of your technical analysis before opening a long or short position. Make sure you are comfortable in reading selected indicators and data on different timeframes. Trading activity of the Futures Trading is much faster than on Spot trading and you are required to make fast decisions based on data you have.
- Decide on the amount of leverage you would need to use as it will predefine your initial margin and liquidation price. It should correlate with the technical analysis and possible risks you have picked before.
- Select the order type at which you want to open a position. It can be an immediate entry or postponed when the price is right.
- Set the realistic target price to manage your risk & reward ratio, and secure your profit by planning ahead.
- Understand your liquaditation price and adjust if necessary to prevent your position being closed during local trend reversals.
- Select the initial margin that you can use to maintain and sustain your position. Remember that this will be your funds that will keep the position open as long as you want or the market allows. All losses incurred will be covered using your initial margin, as well as leverage fees.
♟ Diversification of trading strategies
Consider Bitsgap’s automated strategies for a spot market that proportionately distribute your investments by each price level within a predefined trading range.
Bots are designed to buy a cryptocurrency low and sell high. With a high-frequency algorithm, it has become possible to seize almost every price swing regardless of the market direction and volatility. Below is the example of a bot trading on the LEND/USDT pair.
For the period of 86 days, it has managed to execute 1033 trades and has accumulated 60.5% of profit to initial investment.
As the vast majority of cryptocurrencies are highly correlated to Bitcoin it makes traditional assets diversification hard. However, you can diversify with trading strategies: automated trading, manual spot trading, futures trading for hedging and speculation.
Although futures trading presents higher profits than spot trading, it should be approached with caution. Take the necessary risk management procedures, diversify with trading strategies, do not forget about the Stop-loss.
Written by Dmitry Perepelkin