Derivatives are financial instruments whose value is derived from the value of an underlying asset. They allow you to bet on either direction of the market using leverage (we will go into this later) without owning the underlying asset. They were invented by hedge funds to, you guessed it, hedge against their portfolios. But over time, they have gained popularity from retail traders to gamble of the direction of the market using leverage.
Derivatives have an enormous impact on the Crypto markets. In fact, they represent approximately 75% of all crypto trading volume, mainly from perpetual futures contracts.
Perpetual futures contracts (or ”perps”) are a popular derivative that allows traders to use leverage to long or short the market without worrying about an expiry date like traditional futures contracts.
Because derivatives are where the majority of trading happens, understanding the data we can pull from these contracts gives us at Alpha Ai an enormous edge against the rest of the market. We are able to understand market sentiment, and emotions, to counter trade the market when people are making mistakes.
Below, we will break down a few metrics to follow so that you can begin to dip your toe into the world of derivatives and how to understand this massive financial casino…
Now, how can we combine these metrics to understand key pinpoints in the market?
Downtrend Reversal: Negative funding rates + fast drop in open interest + large liquidation event = Reversal. Why?
Negative funding rate = Market is excessively short
Fast drop in open interest = Shorts are either being closed in profit (buy pressure) or longs have been liquidated (no more sell pressure)