Learn the Basics of Perpetual Futures Contracts

The financial markets offer a diverse arsenal of trading instruments, each with its own nuances.

Two popular choices for leveraged speculation, perpetual futures contracts and contracts for difference (CFDs), often leave traders and algorithmic developers scratching their heads about the key differences. This article delves into the intricate world of these instruments, highlighting their similarities and guiding algorithmic traders towards informed choices.

Similarities that Bind:

Despite their distinct names, perpetual futures and CFDs share several key features that attract both manual and algorithmic traders:

• Leverage: Both offer the ability to control a larger position size than your capital allows, amplifying potential returns (and risks).

• No Physical Delivery: Neither involves the actual ownership or delivery of the underlying asset. Settlements occur in cash, based on price differences.

• 24/7 Trading: Enjoy continuous trading around the clock, unlike traditional markets with limited session hours.

• Hedging Flexibility: Both instruments can be used to hedge existing positions or portfolios against adverse price movements.

Diving Deeper: Where They Diverge:

While the similarities are alluring, subtle differences can impact your trading approach, especially when developing algorithms:

• Settlement Mechanism: Perpetual futures use a funding rate mechanism to maintain price parity with the underlying asset. CFDs, on the other hand, settle based on the difference between the opening and closing price, potentially exposing you to overnight financing costs.

• Regulation: Perpetual futures fall under exchange regulations, offering some degree of standardization and investor protection. CFDs are typically regulated by financial authorities but may have varying rules depending on the provider.

• Underlying Assets: Perpetual futures primarily track traditional assets like cryptocurrencies, while CFDs offer a wider range of assets, including stocks, indices, and commodities.

• Fees: Fees associated with perpetual futures often involve funding rates and trading commissions. CFDs typically involve bid-ask spreads, financing costs, and potential inactivity fees.

Algorithmic Opportunities: Tailoring Strategies:

The choice between perpetual futures and CFDs for algorithmic trading hinges on your specific needs and the strategy you're deploying:

• Mean Reversion Strategies: Both instruments work well, but consider funding rates in perpetual futures.

• Trend Following: Perpetual futures might be more cost-effective for long-term trends due to potential rollover costs in CFDs.

• Arbitrage: Use the wider asset offering of CFDs for cross-market arbitrage opportunities.

• Market Making: Perpetual futures offer smoother funding mechanisms for continuous market making strategies.

Remember:

Both perpetual futures and CFDs offer attractive features for algorithmic trading, but understanding their subtle differences is crucial for informed decision-making.

Consider factors like underlying assets, fees, regulations, and your specific strategy before taking the plunge. Utilize backtesting and rigorous risk management practices regardless of your chosen instrument.

Francisco F. De Troya

Algorithmic trading & derivatives professional.

Executive Chairman, Blockmas

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