What is Contract Trading: How to Trade Crypto Derivatives on Phemex
Contract trading is a legal contract between a trader and an exchange to buy and sell contracts of an asset like Bitcoin (BTC). Contract trading allows traders to access direct exchange capital with a larger margin than they initially invested to increase their profit potential.
Contract trading, also known as margin trading, is a type of derivative — a financial instrument that derives value from the spot value of a crypto asset. Phemex is among the world’s 20 largest derivative trading exchanges. The difference between spot trading and derivative trading is that users don’t own the underlying asset, but they own contracts associated with the spot price.
What Is a Contract in Trading?
A contract in trading is the legal contract in which two parties agree to certain terms:
- Exchanges: Agree to pay a higher sum of money proportionate to the trader’s initial investment should their trade end up profitable.
- Traders: Agree to put up collateral and risk losing crypto assets should the trade go in the other direction.
Traders must choose margin for trading contract options. The margin is the amount of leverage a trader uses to increase their profit potential in proportion to the initial amount of money they’re investing. Traders can choose 2x, 3x, 5x, 10x, 50x, and up to 100x.
The risk-to-reward ratio in margin trading is proportional. If there’s a higher leverage multiplier, the profit potential increases substantially. The risk of liquidation increases with higher leverage as well because the trader is playing with borrowed capital.
Bitcoin Contract Trading: An Example
A trader wants to trade 1 Bitcoin on Phemex (at a price of $40,000 USDT), but they only have $400 USDT in their account. A 100x leverage trade would allow them to borrow money at a ratio of 100:1 and effectively trade with a whole Bitcoin worth $40,000.
The $39,600 price difference is considered borrowed capital. With leverage of this kind, the exchange can liquidate a trader if their position moves by a fraction of 1%. With smaller margin positions such as 3x, Bitcoin could shift more than 10% against the trader’s position and they still wouldn’t be liquidated.
If the position is open, the remainder of the funds deposited in the trader’s account act as collateral for the trade. A trader can’t lose more than what they have in their account as collateral.
Traders can open and close trades using limit and market orders — similar to spot trading. The only difference is the number of contracts purchased and the leverage used.
Crypto Derivatives Market Size
The crypto derivatives data we can extract from data aggregators shows that the daily crypto derivatives volume among all crypto exchanges is over $100 billion. Out of the total crypto derivatives market size, Phemex processes 2-3%, with a daily volume surpassing $2-3 billion.
The Bitcoin derivatives market comprises over 50% of the crypto derivatives market. In 2021, crypto derivatives beat spot markets by trade volume for the first time in history. Crypto derivatives are still new and maturing. They offer similar tools as traditional derivative markets.
The market for non-crypto derivatives worldwide is said to be worth over $1 quadrillion. This combines derivatives for assets such as stocks, forex, precious metals, and more.
Derivative vs Spot Trading
Spot trading works by purchasing assets and taking ownership of them on a permanent basis. Derivative trading works by purchasing contracts related to the asset and the spot price dictates the profitability of these contracts.
Assets such as Bitcoin are not owned by the trader in derivative trading. Even in stock markets, derivative traders don’t actually own the shares. Phemex users can trade derivatives for most coins listed on our spot market. As a top crypto derivatives exchange, we aim to expand our contract offerings to all spot pairs listed on our exchange.
Traders retain full control over their trades when they trade derivatives. For instance, they can long/short, adjust leverage, set take-profit/stop-loss options, and close their positions with limit or market orders.
Derivative and Contract Trading Strategies
Cryptocurrency derivatives trading can be easy. Longing and shorting are the most-used derivative trading strategies, combined with leverage.
- Long (Buy): Contract positions that bet the price of Bitcoin or an altcoin will increase.
- Short (Sell): Contract positions that bet the price of Bitcoin or an altcoin will decrease.
If a trader opens a long (Buy) position on Bitcoin, the spot price has to go up in order for them to make a profit from the moment their trade is open. This means that if the price goes down, they risk losing a percentage of their assets.
If a trader is using 100x leverage, the best strategy is to use the minute (1M, 5M, 15M) charts that show minor price fluctuations that affect the price. If they are using 3x leverage, they could rely on hourly (1H, 4H), daily (1D), or weekly (1W) charts to predict future price movements.
Contract trades are much shorter than spot trades because there’s more leverage involved. Traders take profit earlier to hedge against the risk of their position moving against them and close trades faster should the position move against them.
What Are Contract Trading Benefits?
Phemex users enjoy certain benefits for leverage trading compared to other exchanges:
- Higher Leverage. Traders can trade with more money than they own using leverage trading. Phemex allows users to borrow money for futures trades automatically — up to 100x. If their long or short position is profitable, their leverage multiplies their gains proportionate to their initial investment.
- Manageable Risk. Traders can manage their risk by placing stop losses below their liquidation price to avoid liquidation. Using this technique, if they end up being liquidated, the most they can lose are their crypto assets deposited on Phemex.
- Higher Security. All contract trading is done within the exchange. As traders don’t own the actual Bitcoin, there aren’t any security issues concerning the storage of Bitcoin or other crypto assets. Phemex is one of the most secure exchanges in the world and traders can feel safe investing larger sums of capital.
- Fast Trades. Phemex has the fastest trading technology of all exchanges, and our user trades are executed in real-time without any delays. We rarely experience downtime, and the risk of liquidation due to maintenance is exponentially lower.
- Trade Options. Phemex users can trade over 39 cryptos on the futures market. We will keep expanding our base to more cryptos in the future.
How to Trade Contracts?
Let’s use Phemex platform for this demonstration. To trade contracts, follow this step-by-step guide:
1 Deposit crypto
Register an account and deposit crypto to trade on the exchange. New Phemex users can win up to $100 in sign-up bonuses. All users can deposit crypto assets like Bitcoin, Ethereum (ETH), Solana (SOL), Cardano (ADA), and 50 other cryptos. These can be used to leverage trade and/or open contract positions.
Pro Tip: If you don’t have crypto, you can visit the “Buy Crypto” section to get started. Our partners accept credit/debit cards and bank transfers. These will be automatically deposited in your Phemex account.
2 Convert spot > contract
Phemex crypto assets are stored in the spot trading account. Spot assets have to be transferred to the contract trading account to trade contracts. Press on “Assets” in the top-right corner and then navigate the “Contracts Trade Account” as seen below:
Under the contracts trade account, you can press “Fund BTC trade account” or “Fund USD trade account” to transfer your assets. We recommend funding USD, because BTC assets work only on BTC contracts, and USD assets are compatible with all other futures contracts.
A new window will pop-up prompting you to choose which spot wallet you want to convert to USD value:
Press on “All” to transfer all assets in your spot account. Then get a quote for the latest price conversion and hit “Confirm”. Congrats, your contracts trading account is now funded!
3 Pick Futures
Phemex has 39 futures contracts available for trade. Visit our contract markets to get started:
Press on “Trade” for any of these contracts and you will be taken to the trading page.
4 Open a Position
For this demo, we chose the BTC perpetual futures contract. Traditional futures contracts can expire weekly, monthly, etc. Perpetual means that they last forever, and the contract will not expire until the trader closes the position or gets liquidated.
In the top-left corner, you will notice a trading panel where you can input custom settings for your trade. Press on “Market” to check the current rate for each contract:
Next to “Quantity,” you can find the current price of contracts. If 1 contract is worth 0.001 BTC that means that each contract is worth $40. On other perpetual contracts such as LINK, the contract may be worth 0.2 LINK. The price per contract varies by the crypto.
Use the sliders on the left to adjust the quantity and the leverage. For this demonstration, we will open a long position on Bitcoin with 3x leverage. These are the parameters we need to input:
With a balance of $17,823 USD, we can purchase 1333 contracts ($40/contract). The position is increased to $53,188 using 3x leverage. We can now click on “Buy” and a confirmation window will appear allowing us to set our take profit and stop losses:
We can adjust our take profits and stop losses optionally:
Press “Confirm” and your trade will go live. A confirmation window will appear near the bottom-right:
We successfully purchased 1333 contracts, and now trading with 3x more money than our initial investment.
5 Start Trading
The position data will be updated in real-time below the Bitcoin perpetual chart. Under the “Open Positions” menu, you can monitor your recent trades:
The following are the most important parameters:
- Symbol: Contract we are currently trading.
- Size: Total amount of contracts purchased.
- Entry price: The spot price of Bitcoin when we entered the trade.
- Mark price: A real-time mark price for the contract that is used to calculate PnL gains and losses.
- Unrealized PnL: The unrealized “Profit and Loss” shows us how much we’re in profit or how much we’re losing.
- Realized PnL: Realized PnL calculates realized profit and subtracts fees owed to the exchange.
If you are ready to close your position, you can press on “Market” and sell the contracts. If you want to delay your sale at a further price point, you can press “Limit Order” and input custom price parameters. The funds from the sale will be automatically deposited in your account.
Contract trading is a part of crypto derivatives trading that allows traders to increase their profit margins by using leverage. To understand how contract trading works, users must be familiar with spot trading and crypto charts.
Cryptocurrency derivative trading is recommended for intermediate and advanced users. As they carry higher risk, they should only be traded by people with a better understanding of the trading tools and the volatility of the crypto markets.