Derivatives Trading for Dummies

8 min readApr 26, 2023

A sophisticated crypto market participant, circa 2023

Disclaimer: this article was made possible thanks to the support of Bybit. If you like it and would like to try the exchange, get an account here: partner.bybit.com/b/apg

The Basics

Derivatives are contracts that track an underlying asset, and are tradable via two buttons: the green button to long and the red button to short. They became popular in crypto for several reasons:

leverage,
leverage,
leverage.

As a side-effect of the above, they offer great liquidity and low fees, and are supported by powerful matching engines, so in general the trading experience is great.

This article is intended for beginners, so feel free to skip bits if you're an accomplished derivatives trader already.

I have structured the article as a 10 bullet point piece, each of which being an important lesson that I learned (often the hard way), and that I wish I knew before dabbling into trading crypto derivatives.

Trading crypto derivatives is hard
Useful learning resources
Finding your style
Entering trades
Profit taking
Managing positions and leverage
Tracking performance and results
Holding duration and life balance
Indicators and tools
Crypto Twitter

Trading crypto derivatives is hard

Of all the ways one can hope to make it in crypto, trading derivatives is probably the hardest. Why?

The tokens that are listed on CEXs have already completed part of their early growth cycle. They may even by ripe for selling off by the evil VCs who acquired the tokens cheap, and are looking to hedge their bags once derivatives become available.
Price action on derivatives is by nature very adversarial. Every time you buy a long contract, someone on the other side is placing a short bet. They are often richer, smarter and better informed that you are.
Gone are the days where prices would go up only. Every player needs to eat, which means the path that the price follows is the result of sometimes intense conflicts to move the price one way or the other, which creates infamous patterns such as the the "Bart" or the "Burj Khalifa".
Despite the above, crypto derivatives are a convenient and affordable instrument to express views on price movements, and if you manage to develop an edge in that niche, then why not give it a go?

Useful learning resources

Crypto Twitter has a mountain of content and there is more to learn everyday from the valuable information people share. If I had to pick three items, I would recommend:

Hsaka's thread on the most common patterns. Crypto price action tends to repeat, a lot. Therefore, it is profitable to identify patterns that keep repeating and to create trade ideas around them.
Trader Dante's how to smash 2023 thread. It contains a lot of references to his previous threads and there is a LOT to learn from it. My favorite parts are the ones relating to managing positions and developing an edge.
Cred's YouTube channel. The best videos ever produced on crypto price action concepts. Foundational content.

Finding your style

There are many ways to trade derivatives. A few of them are:

purely hedging, i.e. neutralizing any spot exposure by shorting the same amount of tokens on an exchange;
speculating directionally, up or down;
delta neutral strategies such as market making;
mean reversion strategies (fading extreme moves);
trend following strategies;
all of which can be executed on low timeframes or high timeframes…

At the end of the day, finding what works for you is the most important. In my case, I know that I am not particularly fast or precise enough to trade micro-rotations on low timeframes… so I wait for certain conditions to develop where for example a short squeeze might happen. If that happens, I know that I will be able to trade a large % move, where execution may be more forgiving than in tight ranges.

A large number of regular players can be grouped under the "directional ape" umbrella. Buy low sell high type of strategies. These strategies do very well when the volatility is suitable, but can be unprofitable when conditions are "choppy". I tend to sit out choppy conditions for that reason (as a directional ape).

Entering trades

How to pick good coins?

This is half the battle. CEXs offer a large number of tokens and not all of them are created equal. As a directional ape, things that matter to me are: is the coin trending? is the volume big? is the trend smooth? are the impulses strong? how predatory is the price action? etc, etc.

The CEX top gainers list can be very useful, so can be trading metrics dashboards like Orion, or derivatives data dashboards like Coinglass.

Where to enter?

Buy low, sell high… and that's really all there is to it!

A few ways I like to enter:

Limit or market entries around moving averages (specifically EMA 36).
TWAPs. Binance has a built-in TWAP tool that is great. On Bybit, one needs to use a third party terminal like the Insilico Terminal.
Scaled orders. Laddering orders increases the odds of getting filled at lower prices. Example:

Scaled bids to enter a trade on Bybit, using Insilico Terminal

Other indicators that may help find confluence and justification for entries: moving averages, horizontal levels, etc…
I also find monitoring liquidation flows very useful. Either entering into long liquidations tapering off, or into short liquidations accelerating.
Generally speaking, as a momentum trader… if a coin is not going to pump hard or nuke hard, there is little reason to open a trade or to remain in one.

Profit taking

I spent a very long time round-tripping a lot of trades, i.e. taking directional trades only to see price come back to my entries within hours and then feel upset about it. Entering trades is easy, but exiting them is an art that very few people have mastered. Here are a few tips that have helped me improve:

When a trade moves your way, take 25% of the position off quickly to "pay for the trade". There is a high chance price revisits your entry anyway, so at least you're taking something home before round-tripping the whole unrealized PnL!
Setting offers in advance for the full position. The psychology is simple: if you don't set orders in advance, you will try to time the exact top, then miss it, then hope for price to go up again, then fail to sell again, etc…

Sample scaled orders to exit a trade as price moves up

I like to think of trades as some form of commerce, maybe like selling perishable goods. If you're selling food, you want to have a quick turn-over. You don't want to keep the food items in your shop forever. Buy the items, sell them, make a buck, be happy.

Managing positions and leverage

A simple rule of thumb: 2 concurrent positions is generally enough. Maybe 3 or 4 if conditions are particularly easy. Crypto markets are heavily correlated and everything will go up a lot on a good day, and rug at the same time if bad news hits… so adding positions is not only redundant but multiplies risks unnecessarily.

The topic of leverage has been discussed at length on Twitter. Generally, it's best to avoid using it or to keep it low. Having said that, if an exchange is offering the possibility to enter a position by posting a small amount of collateral instead of a large amount of collateral, maybe leverage is acceptable and can be useful in some cases, if risk is managed.

Performance and results

You can't improve what you don't track! That is particularly true for trading. When I started using perpetual contracts, my only metric was my total balance, I had sometimes little awareness of how many trades I took in a given week or how much I spent on fees.

Tracking via a simple spreadsheet is completely fine: date, trade direction, entry, exit, PnL, reason for the trade, comment… Keep it simple.

A better way is to use an automated trade journal such as CoinMarketManager. If you create your trading account using their ref link, then access is free, which is a great way to get started using an automated journal.

Holding duration and life balance

Holding duration depends on trading style and personal preferences.

Scalpers will hold positions for a few minutes, day traders for a few hours, and higher timeframe traders may hold them for months.

Given the fact that volatility has been aggressive in recent months, I have found that the sweet spot for me is 4 to 12 hours.

Regarding holding trades overnight, my friend alle once had the following words: "don't try to make in your sleep the money that you didn't make while you were awake". I have found that to be true and relevant in many cases.

Indicators and tools

Indicators:

The TradingView indicators that I use are from Insilico Research and I think they're great!
Generally, people will end up simplifying their reliance on indicators a lot as time goes by. At the end of the day, a simple EMA indicator or RSI indicator can be enough to run a simple trading system.

Data feeds:

Orion Screener: soon to include a Command Line Interface, which I am looking forward to.
Coinglass Funding Rates: remains one of my favorite way to scan coins. Sort by highest to lowest rates, and see how that correlates to price.
Binance Liquidation tape: a simple Telegram feed with Binance liquidations > 50k.
Bybit Liquidation tape: a fun liquidation feed for Bybit. Come for the data, stay for the emoji reactions.

Tools:

Ichibot Command Line Interface: a simple yet powerful tool to execute advanced order types and commands using the exchange API.
Insilico Terminal: a robust terminal that connects to both Binance and Bybit.
Laevitas Derivatives Dashboard: useful dashboard to monitor open interest and changes in metrics in real time.

Crypto Twitter

Crypto Twitter, or CT, has become the Agora of crypto traders. Nothing moves prices without being mentioned at some point on Crypto Twitter.

All the major trading desks maintain a Twitter account, and so do a lot of individuals who have market-moving power. Being able to interact with more experienced traders has been beneficial to me in my journey, and I strongly encourage beginners to seek advice and build relationships with the accounts they like on Twitter. Most people are kind and patient, and willing to help.

As with anything, pay it forward and contribute positively, and chances are you'll be rewarded beyond your expectations.

Good luck trading!