Futures trading has grown significantly over the past year, as evidenced by the general increase in open interest. Open interest is the total number of pending contracts, and this figure has increased from $ 3.9 billion to $ 21.5 billion currently in six months, ie by 450%.
Traders sometimes assume that a high or low financing rate and high open interest rate indicate a beef market, but as the Cointelegraph previously explained, this is not the case. In this article, we take a quick look at the level of financing and how traders interpret this calculation when trading permanent futures contracts.
Funding levels can be an indicator for bulls and bears.
Permanent contracts have a built-in price that is usually charged every eight hours to ensure that there is no imbalance in currency risk. Although the open interest of buyers and sellers is always the same, their influence can vary.
When long positions require more influence, they pay commissions. Therefore, this situation is interpreted as bullish. The opposite happens when short positions use more leverage, which results in a negative financing rate.
When traders use high leverage levels, analysts point to the risk of a cascade settlement. While this is true, this situation can unfold for several weeks, and sometimes debt consolidation happens alone. Therefore, such an indicator should not be used to predict local peaks as the data show.
Emerging markets tend to generate positive financing rates when buyers are very enthusiastic. However, this situation creates the perfect storm for short sellers, as a 5% price correction aggressively settles 20x leveraged buy trades. These orders can push the price down, cause a fall of 10% and thus trigger a series of settlements.
For this reason, experts and analysts often state too high financing rates as the main reason for successive liquidations when the market turns red, although the financing rate may remain unusually high below heights.
Financing rate can reveal local downturns
Note that the funding rate was 0.15% or higher for each eight-hour session during February when there was no local summit. This rate is 3.2% per week and is somewhat stressful for long traders. Trying to determine the time of the peak load in the market using this indicator rarely gives good results.
On the other hand, BTC price declines occurred on 27 January and 28 February during periods when the funding ratio was low. These moments show that traders are reluctant to take long positions, and this shows a lack of trust on their part.
Lower financing rates should be seen in context
Although this indicator can help to determine whether a local bottom has formed, it should certainly not be used alone, as the financing rate usually disappears after a strong price correction.
Furthermore, continuous periods of higher funding will attract arbitrage traders who will sell standing futures contracts while buying monthly contracts at the same time. Therefore, you need to use this scale carefully.
To ensure that investors are unsure about going long, the monthly contract premium, known as the “base”, should be monitored. Unlike a fixed contract, these fixed futures contracts do not have a financing rate. Therefore, the price will be significantly different from the regular spot exchange.
By measuring the cost gap between a futures contract and the regular spot market, a trader can measure the level of an upward trend in the market. When there is over-optimism among buyers, 3-month futures will trade at 20% or higher (base) annually.
A combination of indicators can set local declines in the BTC price.
On the other hand, when an indicator points to a local bottom, it usually means that traders’ confidence gains strength. Therefore, in a scenario where the fixed contract financing rate is low, there is better “confirmation” than buyers using lower leverage.
By combining a constant financing rate for a contract with a monthly contract base, the trader will gain a better understanding of the market sentiment. Similar to the popular “fear and greed” indicator, traders should buy when others show mistrust.
This scenario usually occurs when the funding rate is less than 0.05% for the eight hours and futures lows on a three-month basis, as shown in the chart above.