Best Bitcoin Derivatives Trading Exchanges
Derivatives Trading 101
All those active in the trading world have probably heard about derivatives trading. Typically, it’s more attractive to experienced traders. Of course, this doesn’t mean it comes without risks. Below we are going to explain what is a derivative, how does derivatives trading work and what are the risks associated with it.
What is a Derivative?
The derivative is a term used for anything – a contract, security – that gets its value from its relation to another asset such as bonds and stocks.
Traders usually get into the derivatives trading because it gives owner more freedom than the stock or bond. Derivatives contracts are usually non-binding, offer the possibility to get high leverage returns, and financial gurus love them because they allow the use of advanced trading strategies.
Types of Derivatives
There are thousands of different kinds of derivatives, but the majority of the trading revolves around the key three:
Options are contracts made between two parties to purchase or sell an asset at a given price. This the most common type of derivatives.
Swaps give traders the opportunity to trade the benefits of their securities between them. For example, if one investor holds a bond with a fixed interest rate, but is in a business where a varying interest rate could be more profitable. He may enter into a swap contract with another investor in order to exchange their interest rates.
Futures are somewhat similar to options, although the use of assets is different. Futures are typically used for buying the rights to trade with a commodity, but on the trading platforms, they are usually used for buying and selling of financial securities.
This abbreviation stands for Contract for Difference and refers to financial instruments with which profits can be achieved by correctly predicting price developments. For example, those who trade in equity CFDs do not own any shares in the company but only speculate on how the share price will develop.
When trading these derivatives, a trader acquires the right to buy or sell a specific underlying asset within a specified term and at a specified price. Such transactions are also referred to as call or put orders. Warrants are related to derivatives such as options and binary options.
There are also put and call orders and binary options are also limited in their term. The all-or-nothing principle applies. If you speculate on rising prices with a call trade and remain right at the end of the term, you will receive a return fixed in advance. If the trader is wrong, the money invested is gone. There are different types of binary options, including range, one-touch and turbo options, which have a particularly short term.
These financial instruments also involve an indirect investment in a specific underlying. However, unlike many other derivatives, certificates are primarily suitable for experienced investors. There are innumerable different certificates and their range extends from simple to highly complex certificates. They all vary in characteristics such as maturity, security or risk level and it is sometimes not so easy to see through them.
The Chances of Derivatives Trading
Trading in derivative financial instruments basically offers unlimited opportunities to increase your own capital. Because there are so many underlying instruments available, there are many trading opportunities in the course of a trading day that are just waiting to be exploited. The underlyings offered by your broker alone represent a restriction, and if you want to have a large selection of different underlyings, you should make a broker comparison and find out which broker has the most to offer in this respect.
Among the other advantages of derivatives is the fact that access to trading is also available to small investors. As described above, a security deposit is sufficient for trading to move positions that would otherwise be out of financial reach. In addition, most derivatives are very simple in structure, so even new traders can find their way around very quickly.
The Risks of Derivatives Trading
The use of derivatives can bring a lot of good, but it’s often an instrument of destruction as well. Below are some of the risks associated with derivatives trading:
The majority of derivatives are traded on the open market. This can be a big problem for investors, as the asset’s value constantly changes. Due to this volatility and unpredictability of the negotiated terms between the new owners, it is possible for investors to lose their entire investment in a minute.
Putting a price on a derivative can be very difficult as it’s based on the value of other securities. Since it’s already quite difficult to determine a price for a share of stock, it becomes way harder to put an accurate price on a derivative based on that stock. And since there are not as many traders as we have with stocks, there are much larger bid-ask spreads, which can often lead to overpriced derivatives.
Probably the biggest reason why derivatives are so risky lies in the fact that every derivative has a specified contract life. After the expiry, they become worthless. If the investment bet doesn’t bring a profit within the specified time frame, traders will face a 100 percent loss.
Many traders find it hard to understand how derivatives work. Scammers often use derivatives to build complex scam schemes to trick both amateur and professional traders.
An example of trading with derivatives
In order to make it easier for you to understand how derivatives work, we would like to look at a concrete example of trading CFDs below. As already mentioned, the so-called leverage effect applies to trading in derivative financial instruments. Leverage is the ratio of the capital employed to the volume actually traded.
Online brokers who offer trading with derivatives enable their customers to trade with borrowed capital. If, for example, a leverage of 100:1 applies, this means that you trade a hundred times your stake and for every euro you use, the broker adds 99 euros to the top. So if you were to buy 100 shares at a value of 100 euros per share directly, you would have to pay 10,000 euros. With a leverage of 100, you only pay 100 euros when trading in difference contracts. This amount is called a margin and represents a kind of security deposit that you deposit for trading.
The higher the leverage, the more money you can earn per price point and the faster you can lose it again. At a leverage of 100:1, the market must run 100 points against you for your bet to be exhausted and at a ratio of 400:1, 25 points are enough to completely melt the margin.
While investing in derivatives can seem appealing, it’s quite risky, and it’s definitely not for beginners. If you’re planning to start investing in the derivatives, check all the options and learn everything you can about the derivative in order to minimize the risks.
Use of advanced trading strategies is recommended for those looking to trade with the absolutely minimal risk.