Hello everyone, today I would like to present you a great sentiment indicator which is Funding Rate. Before we get into the more advanced things as it pertains to the funding rate it's important to know by definition what the funding rate actually is.
What is Funding Rate?
Funding rates are periodic payments either to traders that are long or short based on the difference between perpetual contract markets and spot prices. Therefore, depending on open positions, traders will either pay or receive funding. Crypto funding rates prevent lasting divergence in the price of both markets. It is recalculated several times a day.
Basically, when funding is very positive that means that the perpetual is trading way above the spot when funding is very negative that means that the perpetual's trading is way below spot. In a bull market, the majority of the market is long so in most cases if you are in a long position you are required to pay the funding rate. Things do change occasionally, we may see a downtrend in the market where the funding rates flip. Funding rates run every eight hours so every eight hours funding rate is charged to your open position. If you decide to scalp trade and you're in and out of your trades before that eight hour funding fee hits then you could effectively avoid paying the funding rate. So primarily funding rates are targeted towards individuals who are either swing trading or they have a position open during one of these eight hour expiration times.
How Can We Use It?
When the funding rate is super positive that means to me traders are overvaluing the coin and the coin will soon fall and when the funding rate is very very negative that means that a lot of people believe that the market's going to fall and that makes me think the market will rise. Also, you can use Funding Rate to identify trapped traders. So let's go look at some examples
So past 2/3 weeks, you could see funding rate got a lot higher. We went on an average of about 0.05. So this to me is a sign that futures traders are really overvaluing BTC and the market most likely will fall and as we can see on the chart market fell actually several times. And then the market actually stopped falling when traders kind of lost that bullishness on BTC and after that market goes up again, traders became again bullish, and after that market fell again. That situation happened for times as we can see.
In this case, we have had a downtrend for a couple of weeks, then price has bounced twice and the second time we see that Funding Rate grew to around negative 0.06 which is high. To me, this is a sign that futures traders are really undervaluing BTC and the market most likely will rise. After that market rose 10%. From such a situation we can draw an example that if most of the people entered a short position at that moment it means that they are at a loss, which means that if the price comes back to this level most of them will exit their short position which will result in the price increase. And this is exactly what happened. The price went down to that level, traders exited their positions and the price went up by 7%.
Here we have a similar situation on ETH chart. Funding rate went up to around 0.08. Then price fell and this left a lot of traders with losing positions. So if I am this trader I have two reasonable options, close position on loss or wait for price to come back to my entry level., and that is why after a few days we got rejected from that level a few times because most of traders who were in long positions just exited trade on break even.
Conclusion
Funding rates are a unique dataset that most people in traditional finance are not familiar with. Personally, I think this is one of the best indicators we can find. If we add some other indicators to it like open interest liquidations ect. we can create a very profitable strategy.
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Hope you found today’s article helpful. Have a nice day :)
