Over the course of the past 30 years, Wall Street bankers and financial professionals have created a laundry list of new products for the investment community. These days, there is an “alphabet soup” full of new investment vehicles. Despite the growing assortment of new innovations, each of these products have one thing in common: they can all be placed in one of four different investment categories: stocks, bonds, commodities, and cash.
Without question, the category that provides the greatest amount of volatility is commodities (also referred to as real assets). This category is designed for investors who are searching for a high degree of volatility, in exchange for a large potential rate of return. Historically, commodities have certainly lived up to their reputation as a highly speculative asset class.
The major contributing factor to the volatile nature of commodities is based on the fact that most investors trade commodities through a futures contract. These contracts are created to provide the maximum level of speculation for traders who understand the benefits of futures trading and prefer to participate in this highly volatile environment.
Benefits of Futures Trading Using Leverage and Margin
Why do futures contracts contain so much erratic price behavior? Because the contracts have a high degree of leverage, which can turn a small price movement into a substantial profit or loss. In order to gain a better understanding of a futures contract, and the benefits of investing in futures, let’s review specifically how leverage and margin are used in a typical futures transaction.
Futures Trading Margin Example
As an example, let’s assume that you are bullish on the price of silver. In other words, you expect silver to rise in value. Purchasing a silver futures contract would allow you to realize a nice profit if your bullish analysis is correct.
The futures exchange offers a silver contract with a unit value of 5,000 ounces. Essentially, if you purchase the contract, you own 5,000 ounces of silver. The current price is $15.25 per ounce. Therefore, you own $76,250 worth of silver (5,000 x 15.25). Most investment vehicles would require the investor to deposit the full value of the underlying asset. In this case, the amount would be $76,250. However, you purchased a futures contract, which is a leveraged transaction. Consequently, you are not required to pay 100% of the contract’s value.
In regard to the silver contract, the futures exchange requires a small “good faith deposit” (i.e. margin requirement) of $4,400. In effect, you own $76,250 worth of silver for only $4,400. This is an example of leverage. As you can see from the silver example, leverage allows you to own a considerable amount of a specific commodity with a very small amount of money.
As a trader and investor, you should always remember that leverage is a double-edged sword. If you participate in a leveraged investment and it moves in your favor, you will enjoy a substantial rate of return. Conversely, if your leveraged investment moves against you, the losses will be magnified. Thus leverage is both one of the benefits of investing in futures and one of its chief dangers.
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Comparison Between Digitex And BitMEX
Both exchanges offer their own BTC/USD futures contract. However, the contracts are vastly different in terms of fees, margin and leverage. Which exchange offers the best value? Let’s review the details.
In regard to fees, BitMEX uses an opaque method for charging fees to its customer base, known as maker fees and taker fees. Let’s briefly discuss the difference between maker fees and taker fees.
A maker order is simply a limit order to buy or sell at a specific price. For example, if Jane places an order to buy below the current market price, she is placing a buy limit order.
Conversely, if she places an order to sell above the current market price, she is placing a sell limit order. If the maker order is eventually filled, Jane is charged a maker fee.
A taker order is essentially a market order to buy or sell immediately at the best available price. If Jane places a taker order, she is charged a taker fee when the order is filled.
Exchanges prefer customers to place maker orders because it adds liquidity to the market. In regard to BitMEX, the exchange provides traders with a small credit balance of 0.025% for maker orders.
BitMEX traders who place taker orders are required to pay a fee because they are draining liquidity from the market. The amount of the BitMEX fee is 0.075%. These fees are charged on the buy side and the sell side. For example, if Jane places a taker order to enter and exit at the current market price, she is charged 0.15% (.075 x 2).
At first glance, these fees don’t appear to be too excessive. However, over a long period of time, trading fees will dramatically reduce the rate of return. Quite often, trading fees will determine the long-term success or failure of a trader, particularly a day trader. Consequently, in order to become a successful trader, it’s critically important to reduce fees as much as possible.
BitMEX allows its customers to use leverage when trading BTC/USD. Unfortunately, many BitMEX clients are not aware that taker fees are increased relative to the client’s leveraged position. For instance, if Jane initiates a 10X leveraged BTC/USD transaction, BitMEX will charge a 10X taker fee.
As a result, the standard fee will increase from 0.075% to 0.75%. To make matters worse, the taker fee is charged on the buy side and the sell side. Therefore, Jane’s 10X taker trade on the BitMEX exchange will cost her 1.5% (0.75 x 2 = 1.5). These excessive fees make it almost impossible for Jane to become a profitable trader. In fact, Jane must generate a 1.5% rate of return on the trade just to break even! Without question, redundant fees can destroy a trader’s long-term rate of return.
What about Digitex? How does Digitex compare to BitMEX? First and foremost, Digitex is a commission-free futures exchange. There is no complicated fee structure. Traders are not required to pay maker fees or taker fees. The Digitex exchange is 100% commission-free.
In regard to its BTC/USD futures contract, Digitex uses a very simple perpetual swap futures contract. These contracts are unique in the fact that there is no expiration date or settlement date. As you know, a typical futures contract has an expiration date. Therefore, all contracts must be continuously rolled over as the expiration date approaches. The Digitex contract is never required to be rolled over.
The Digitex BTC/USD perpetual contract has a tick value that is denominated in DGTX. In fact, all account balances, margins and settlements are denominated in DGTX.
What about the tick size? Each BTC/USD perpetual contract has a tick size of $5. Therefore, the minimum Bitcoin price movement is $5. The contracts are traded in increments of $5. For example, Jane can buy a BTC perpetual contract at 6550, 6555, 6560, 6565 or 6570.
Each tick on a BTC/USD perpetual contract is worth 0.1 DGTX. Therefore, each $5 move equals 0.1 DGTX.
In terms of margin, Digitex charges 1% for the BTC/USD perpetual contract. For example, let’s assume the price of Bitcoin is 6550. The initial margin is 6550 / 5 = 1310 x .1 = 131 . Therefore, the initial margin is 131 DGTX. This particular example assumes that the trader is using no leverage. Let’s review an example which includes leverage. Please review the table.
As you can see from the table, the margin requirement decreases as the leverage increases. Let’s review another example, this time using leverage. Jane wants to place a BTC/USD trade using 50X leverage. What is the initial margin requirement based on DGTX, assuming the price of Bitcoin is 7300? 7300 / 5 = 1460 x .2 = 292. Therefore, the initial margin is 292 DGTX.
As you can see, the Digitex BTC/USD contract is a much simpler product compared to BitMEX. Of course, the most important difference between Digitex and BitMEX is the commission rate. Digitex offers a commission-free trading experience. BitMEX charges its customers excessive fees based on a complicated formula involving maker fees and taker fees.
When Digitex launches the mainnet platform on 27 April, don’t be surprised if BitMEX loses a substantial number of customers as they transition to a commission-free experience with Digitex.
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