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How to Use Futures Perpetual Funding Rate: Crypto Trading Guide

The future perpetual funding rate chart can be used as a technical analysis tool. In conjunction with other tools, this tool can help predict whether the market will go up or down. For example, some users think that the market will go up if you have a high funding rate with a high open interest rate. However, that thinking is wrong. We intend to explain in this article what can be analyzed and what conclusions can be drawn from this metric.

Brief Explanation of Perpetual Futures Contracts

Before we talk about the funding rate and why it is applied, we should speak of perpetual futures contracts. Futures contracts are agreements to sell or buy a cryptocurrency at an already fixed price on an already set future date.  This way, traders ensure their gains so they can make precise profit models. 

In contrast, perpetual futures contracts never expire; you can hold them whenever you want. But this pro comes with a con: the price between perpetual futures and spot can diverge. So exchanges set a funding rate to maintain a balance between bullish and bearish positions to reduce divergence. Also, you’ll never own the asset; hence, you only trade a representation of the purchase.

The main advantage of perpetual futures is the leverage. Investors can buy positions higher than their capital and sell assets that they don’t even have!

What is funding rate?

The funding rate consists of periodic payments between traders. These payments are made to maintain the perpetual futures contract price reasonably close to the asset price in the spot market. 

The funding rate is calculated in different ways, depending on each exchange. However, in most Exchanges, it is estimated several times a day, and payment is made every eight hours. Each crypto exchange (Binance, Kraken, crypto.com, among others) has its way of calculating the funding rate that is not always explained in-depth. Nonetheless, for most cases, the funding rate comprises two elements: a fixed interest rate and a premium. 

If the funding rate is positive, the market is bullish, at which time long traders should pay short traders. Conversely, when the funding rate is negative, the market is bearish, so short traders must pay long traders.

Each exchange that has a perpetual futures option reports the funding rate in real-time on its website. 

How does the funding rate payment work?

This value represents a percentage of the amount you’ll have to pay or receive. It’s like a fee but depends if you’re in favor or against the trend. Now, this percentage considers the total amount of your position, know as notional value. In other words, the funding rate is a function of your capital leveraged. 

Let’s make an example. Imagine you have $100 invested in a long position, and it’s 5x leveraged. The funding rate of the exchange is 0.1% daily charged every 8 hours (0.033% each period). If you want to maintain your position for a day, you’ll have to pay  0.5% just for the funding rate. That is 183% yearly! Remember, leverage multiplies every percentage.

Funding rate properties

  • Controls the balance. As we said earlier, the funding rate maintains the equilibrium between buyers and sellers. The more different the futures contract from the spot price, the higher the funding rate. Investors can take advantage of the funding rate claiming it by betting against the trade. Hence, futures prices will approach spot price.
  • Measuring sentiment. The funding rate is essentially a direct consequence of the market traders’ sentiment. For example, you will not take a long position if your sentiment is bearish. This tool can also be used as a bias control. If the market that just had an uptrend and the price is now holding steady but the financing rate keeps increasing, you can say that the market is saturating to the maximum. So it wouldn’t be wise for you to make trades that continue with the trend at this point. It would be more prudent to look for counter-trend opportunities.

Final thoughts

The funding rate is an indicator the market operators’ sentiment. It helps you establish whether a market is saturated with buyers or sellers. Therefore, using only this tool to make decisions on operating an asset could lead to erroneous predictions. Some of the recommended indicators to complement the technical analysis are the relative strength index and Bollinger bands, among others. Also, don’t forget that the market can be affected by external factors too, such as social media.

To make the most informed decisions on managing your crypto assets, make sure you understand your portfolio at all times. ACCOINTING’s crypto tracker automatically connects all your wallets & exchanges and provides you with a real-time overview of changes in your crypto portfolio.

Check out our crypto 101 guide for explanations on similar topics.

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