What is trading futures? Key basics, types and risks

That separation is the fundamental architectural difference you need to grasp. When you are looking at the mechanics of the market to understand futures trading, you are looking at a standardized legal agreement to transact an underlying asset – whether that is barrels of crude oil, bushels of corn, or Bitcoin – at a predetermined price on a specific future date.

However, the vast majority of modern participants never intend to take delivery of physical commodities or actual securities. For the user sitting at a terminal, the goal is rarely to acquire the asset but to capture the variance in price between the entry point and the contract’s expiration. In practice, you are likely to “offset” your position long before the expiry date arrives. This means if you bought one contract expecting the price to rise, you simply sell one contract of the same expiry to close the loop. The exchange nets out your position, and your account is credited or debited based on the price difference. This distinct mechanics – trading the contract rather than the asset itself – is what allows for high capital efficiency and the precise application of leverage.

What is futures trading and how it works

To understand the mechanics, you have to stop thinking about “buying” an asset and start thinking about entering an agreement on price direction. When we ask how does futures trading work, we are examining a system where the value of your position is derived strictly from the price action of an underlying asset – be it the S&P 500 index, a bushel of wheat, or Ethereum – without you ever needing to hold the asset itself.

The contract acts as a tether to the underlying asset. In a healthy market, the futures price moves in lockstep with the spot price (the current market price of the asset), though they are rarely identical. The futures price usually trades at a premium or discount to the spot price, depending on factors like interest rates, storage costs (for commodities), and dividends (for stocks). This difference is called the “basis.” As the contract approaches its expiration date, this gap naturally narrows. On the day of expiration, the futures price and the spot price must converge; otherwise, arbitrageurs would exploit the free money, forcing the prices back together.

For the trader, profiting from these movements is purely a function of directional accuracy and contract size. Because you are trading a legal obligation rather than physical inventory, the mechanism for “shorting” (betting on a price decline) is identical to “going long” (betting on a price increase). You are simply taking the sell side of the agreement rather than the buy side. There is no need to “borrow” shares or pay interest as you would when shorting a stock in a spot market.

Profit and loss are calculated based on the “tick” size – the minimum price movement allowed for that specific contract. Every contract has a specific notional value. For example, a standard Bitcoin futures contract might represent 5 BTC. If the price moves up by $10, your account equity doesn’t move by $10; it moves by $50 ($10 movement × 5 BTC multiplier).

If you are long, you profit when the exit price is higher than your entry price. If you are short, you profit when the exit price is lower. The exchange calculates this in real-time (Mark-to-Market), constantly adjusting your account balance to reflect whether your position is winning or losing based on the current tick. This is why futures are capital efficient: you aren’t paying for the 5 BTC upfront; you are only putting up enough collateral (margin) to cover the potential daily fluctuations in that tick value.

Perpetual vs fixed-term futures

The primary distinction between these two instruments lies in how they handle the dimension of time. In traditional markets – commodities, indices, treasuries – contracts are finite; they have a birth date and a death date. In the cryptocurrency ecosystem, however, the “Perpetual Swap” was engineered to remove the expiration date entirely, creating a trading experience that mimics the spot market while retaining the leverage of a derivative.

Fixed-term futures – the traditional approach 

Fixed-term contracts (often quarterly or monthly) are the standard in traditional finance. When you trade these, you are speculating on the price at a specific date in the future (e.g., “BTC-29MAR”). Because the settlement is delayed, these contracts rarely trade at the exact spot price. They trade at a premium (contango) or discount (backwardation) based on the cost of carry and market sentiment.

The critical mechanic here is expiration. As the contract approaches its settlement date, the price must converge with the spot price. If you hold a position past expiration, you are subject to settlement – either physically delivering the asset or settling the cash difference. If you want to keep your trade open beyond that date, you must “roll” the position: selling the expiring contract and buying the next month’s contract. This rollover can be costly and operationally tedious, introducing “rollover risk” where the price spread between months eats into your profit.

Perpetual futures – the funding rate mechanic 

Perpetual futures (or “perps”) solve the rollover problem by simply removing the expiration date. You can hold a position for minutes or years. However, without an expiration date to force the futures price to converge with the spot price, the market needs a different mechanism to keep the two prices aligned.

This mechanism is the Funding Rate. It is a periodic payment (often every 8 hours) exchanged directly between buyers and sellers. It acts as a counter-force to momentum.

• If the perpetual price is higher than the spot price (bullish sentiment), the Funding Rate is positive. Longs pay shorts. This incentivizes traders to sell (short) and drive the price down towards spot.
• If the perpetual price is lower than the spot price (bearish sentiment), the Funding Rate is negative. Shorts pay longs. This incentivizes buying to push the price up.

Strategic use cases 

Understanding what is trading futures effectively requires selecting the right instrument for your timeframe.

Fixed-term futures are generally superior for longer-term swing trades or hedging strategies where you want to lock in a specific cost basis and avoid the variable cost of funding. If you are holding a position for months, a volatile funding rate on a perpetual contract could drain your margin, turning a winning trade into a loser. Conversely, perpetuals are the preferred tool for short-term speculation and day trading. The liquidity is typically consolidated here, and for intraday moves, the funding cost is negligible compared to the ease of entry and exit without managing calendar spreads.

Key elements of a futures contract

To truly master understanding futures trading, you must dissect the standardized components that define your obligation.

1. Leverage & margin: futures are leveraged instruments. You never post the full notional value; you post Initial Margin (collateral to open) and maintain Maintenance Margin (minimum to keep the trade alive). This ratio determines your capital efficiency but also your liquidation price.
2. Contract size: this is the multiplier. One standard crude oil contract isn’t one barrel; it’s 1,000 barrels. A mere $0.10 move in the asset price equals a $100 change in your account equity.
3. Expiration date: the terminal date of the agreement. As this date approaches, the futures price must converge with the spot price. Traders must decide to “roll” (extend) the position or face settlement.
4. Settlement: the final execution. Physical Settlement involves actual delivery of the commodity or certificate (rare for retail). Cash Settlement – the industry standard for speculators – simply debits or credits the price difference to your account balance.

Crucially, this is an obligation, not a choice. Unlike an options contract, which grants the holder the right to walk away if the market moves against them, a futures contract binds both the buyer (the long position) and the seller (the short position) to the agreed terms. If the contract expires while you hold it, the transaction must occur, or depending on the contract specifications, the cash difference must be settled.

Advantages of crypto futures trading

The appeal of derivatives isn’t just “more risk”; it’s the decoupling of price exposure from asset custody. When you analyze how does trading futures work in the crypto ecosystem, you find a mechanism designed specifically for capital efficiency and agnostic directionality.

In spot markets, your PnL is strictly a function of asset appreciation – you are long-only by default. In the futures market, “shorting” is native. It is simply selling a contract to open a position. This symmetry allows you to profit from downside volatility just as easily as upside, or more importantly, to hedge. You can maintain a long-term spot holding (cold storage) while shorting an equivalent value in futures to neutralize your delta during a bear market, effectively locking in a USD value without ever selling your coins.

Then there is the matter of capital efficiency. If you want to trade a $50,000 position in spot, you need $50,000 in liquidity. In futures, utilizing 10x leverage, you might only need to post $5,000 as Initial Margin to control that same notional value. This frees up the remaining $45,000. It’s not just about gambling with more money; it’s about opportunity cost. That free capital can be deployed into yield-generating protocols or used to hedge other correlations.

Finally, this structure enables “market neutral” strategies like the Cash and Carry trade. By buying the spot asset and simultaneously shorting a futures contract trading at a premium (contango), you can capture the price difference (the basis) as realized profit when the contracts converge, regardless of whether the market crashes or rallies.

How to start trading futures

Accessing these markets requires specific infrastructure. For the retail trader, this usually means a centralized exchange like Binance or Bybit for maximum liquidity and depth, or Kraken for regulatory robustness in Western jurisdictions. If you prefer on-chain transparency, decentralized protocols like dYdX or GMX offer self-custodial perpetuals, though often with slightly higher latency and different fee structures compared to their centralized counterparts.

Once your account is funded – typically by transferring USDT or USDC from your spot wallet to a dedicated derivatives wallet – you face your first critical decision: contract selection. You must choose between USD-M (stablecoin collateral, linear payout) and COIN-M (asset collateral, non-linear payout). The former is intuitive for calculating PnL in fiat terms, making it the standard for most speculators. The latter is ideal if you are a long-term holder of the asset (like Bitcoin) and want to compound your stack while hedging, as your collateral itself appreciates or depreciates with the market.

Next is risk configuration. Before placing a trade, you must select between Cross Margin (sharing your entire account balance across all open positions to prevent liquidation) and Isolated Margin (limiting risk to a specific allocated amount per trade). This is where you set your leverage slider. Remember that leverage dictates your liquidation distance: a 20x leverage setting means a mere 5% move against you wipes out your allocated collateral.

Finally, execution. Avoid market orders unless immediate entry is critical; they incur higher “taker” fees and slippage. Use limit orders to act as a “maker,” which often grants you lower fees or even rebates for providing liquidity to the order book.

The derivatives market is a sophisticated mechanism for price discovery and risk transfer. While the leverage is seductive, the professional approach is to view these instruments as tools for hedging spot exposure and capturing volatility rather than simply gambling on direction. Ultimately, what is futures trading if not the disciplined management of probability and time? Success lies not in predicting the future with certainty, but in structuring your contractual obligations so you can survive the variance.