Dangers of Longing Inverse Contracts
For some reason most people do not think or talk about dangers of longing inverse contracts.
Let me break it down for you. If you long inverse contracts, mathematically you are set to lose money. Let’s explore 2 of the most famous exchanges and see how their liquidation price vary. Also, we will explore the reason why it happens.
Before we jump into the details, let’s refresh our memories with how leverage exactly work.
If you use 100x leverage and the price moves 1% against you, you get liquidated
If you use 20x leverage and price moves 5% to the opposite direction, you visit the liquidation blvd.
If you use 2x leverage and price moves 50% against you, you get wrecked.
If you use 1x leverage, ideally you shouldn’t get liquidated right? Uhm not quite right. You will get liquidated way before than where you think you’d
Alright, now that we are warmed up, let’s check Bitmex. Bitmex is the most popular leverage website that offers inverse contracts.
See here, if you used 1x leverage to open a position at 10k, you would get liquidated at 5k. Exactly at a 50% drop. Why does this happen?
On Bitmex, you deposit Bitcoin for collateral and you buy contracts that are valued and locked in at 1$. As Bitcoin price goes down, the value of your collateral goes down and you get liquidated 2 times faster. 100 contracts would have a locked in value of 100$ at any given time. If you have deposited 100$ worth of Bitcoin when BTC was at 10k, yes, your effective leverage would be 1x at that point. However, the bitcoin you have deposited now is worth only 50$ while you still have a position that’s worth 100$. So your leverage effectively increases without you realize.
This concept throws many of the traders off and messes up with their risk management. Why most people don’t realize it?
The short answer is funding. Funding is positive 99% of the time. So, people think that because they are paying funding, their balance goes down hence the liquidation price creeps up slowly. Although that is true and funding has a negative effect on your account balance if you are long, the inverse nature of the contract you are trading causes for you to get wrecked for the most part.
Alternatively, your risk from an inverse perspective goes down exponentially if you are to short Bitcoin. Why? Because everything we have discussed so far works the other way around for shorting.
If you short Bitcoin with 1x, you will never get liquidated!
When you short 100 contracts with 100$ worth of Bitcoin, if the price goes against you, your underlying collateral goes up just enough to push the liquidation away from you. Let’s explore a few different scenarios here.
You short Bitcoin at 10,000 with 0.01 BTC collateral for 100 contracts which is 100$. If Bitcoin goes to 20,000$ on paper, you should get liquidated right? Nope, not the case! Because when Bitcoin is at 20,000$ your deposit is now worth 200$ and your position is still 100 contracts valued at 100$.
You can see how inverse contracts favors shorts over longs and how dangerous it can be if you are unaware of such underlying danger.
This whole concept might be the reason why whales prefer shorting bitcoin than longing!
In the next article we will explore the nature of USDT settled contracts and how to gain an edge against the market. Stayed tuned!
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