For a proper understanding of the concept of bitcoin futures backwardation, it is important to understand what the price of spot entails, the entirety of the futures contract, and the futures curve. These three concepts make up backwardation. The price of a spot is the price at which you buy an asset or make an initial investment. Assets in this case could be currency or commodity with probable change in price against time through unforeseen and uncontrollable market agents.
On the other hand, a futures contract is a legal engagement that involves the buying or selling of an asset at a future specified date. In futures contracts, prices are also derived from the existence of the contract. In addition to that, the futures curve highlights the relationship between the price of spots and the price of futures. Hence, backwardation is the declining slope of a curve. This concept predicts that the future price of an asset will reduce over time. Now, let’s briefly highlight backwardation in the next heading.
What Is Backwardation?
Backwardation happens when the current futures price of an asset is lower than the current spot price. As the expiration date of the specified contract draws closer, there is always an increase in price which meets at the increased spot price. When compared to when the expiration date was further down, the price of the spot is usually greater than when the expiration approaches a closing point.
The meeting of a btc futures contract of an asset, as it nears the closing point with the spot price is regarded as normal pricing and this happens to be a favorable condition for long futures traders. Backwardation is also a concept used by traders to identify deflation in price over time. This can be identified when there is a decrease in the price of an asset concerning a negative inflation rate. This phenomenon occurs often when there is the unavailability of an asset over a short period.
Things About Bitcoin Futures Backwardation You Must Know
Bitcoin futures backwardation is a concept that every futures trader needs to understand and master for a more profitable trade. To further understand what this concept means, I have streamlined this section to the most important things you need to know about backwardation. Some of these things are:
- Why Does it happen?
Bitcoin futures backwardation happens because of the scarcity of a particular asset in the spot market. It is a result of a shortage of financial instruments in the spot market. To further understand this, let’s look at a practical example with oil as our commodity in view.
Say, for instance, there is a temporary outage in the supply of oil which shoots the price up in the spot market. If at this point, investors perceive this situation to be a temporary one, there is a high probability that most active futures contracts, which are still far from expiration, retain stability while trading at a relatively lower price than the current price. Since we have established that future price and spot price need to arrive at a meeting point over time, investors take the opportunity by buying at the current low price.
- How to Profit From Backwardation
Another point worthy of note about bitcoin futures backwardation is how to exploit it for a guaranteed profit. To this, certain conditions need to be met. First, futures prices need to rise over time to meet higher spot prices with this favoring long future investors. Also, the spot price has to be higher than the futures price upon expiration.
- Pros and Cons of Backwardation
One of the things to know about backwardation is the pros and cons. One main pro of backwardation is the ability to serve as a signal for traders about a probable decline in the future spot price. It is also a useful tool for potential arbitrage participants. On the other hand, one of the cons includes the facilitation of potential losses if there is a continuous decline in futures prices
- Causes of Backwardation
As a bitcoin futures trader, the main causes of backwardation need to be understood. Generally, the main cause of bitcoin futures backwardation is the increase in current demand which consequently results in a decrease in futures contract demand.
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Understanding bitcoin futures backwardation will change your trading game. This does not ultimately imply that you won’t make losses in the market. Knowing the concept only gives you an insight as to what is going on in the market while informing your decision-making. Trading bitcoin futures with leverage involves risks and you should do your proper research before venturing into leverage trading. Beginners should try a mock trading platform before trading with real crypto. Please note that this article is not financial advice and should not be regarded as one
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