We know how to use dollar cost averaging for investing, but when it comes to perpetual crypto trading setting DCA won’t help. So, for trading in derivatives, understanding and applying nominal value can help you understand how your perpetual order will perform under the market conditions that you are in.
In this article, we will cover how understanding the notional value in crypto futures contracts can help you compare the underlying value of a token against its current trading price.
Key Takeaways
- The notional value represents the total value of a leveraged trading position.
- To calculate the notional value of a futures contract, the contract size (in units) is multiplied by its current price.
- Essential for determining hedge ratios and planning trading strategies.
What is Notional Value?
Notional value, also known as ‘Nominal Value ‘or,’ Face Value’ refers to the total value of a position in crypto contract. The notional value in the case of crypto trading refers to the asset you speculate on. For example, if you enter into a crypto perpetual contract, the value of the contract is the notional value.
It represents the overall market exposure of the position, calculated by multiplying the contract size (which includes the leverage applied) by the current market price of the underlying cryptocurrency.
How Does Notional Value Work in Crypto Trading?
Notional value is fundamental in derivative trading, including futures and perpetual contracts. In these contexts, it helps traders understand the size of their positions and the potential exposure they have in the market. Here’s a breakdown of how it functions:
Leverage Calculation: notional value is crucial for determining the leverage ratio in a trade. Leverage allows traders to control a larger position with a smaller amount of capital. For instance, if a trader uses 10x leverage, the notional value of their position will be ten times their initial margin.
Risk Management: Understanding the notional value will help you in assessing your risk tolerance. By understanding the notional value of an asset, you can optimally set your take profit and stop-loss order and adjust the leverage you take in the contract.
Profit and Loss (P&L) Calculation: The P&L of a position in derivatives trading is often calculated based on the notional value. This metric helps traders estimate their potential profits or losses based on the price movements of the underlying asset.
How to calculate nominal value?
Before you enter into a perp crypto contract, look at the position size (the USDT margin you add to enter the trade + the total leverage you opt for). So, for example, you enter into a contract with 100 DOT and take 10x leverage.
That means your contract size equals 1000 DOT.
Notional Value = Contract Size * Current Trading Price
1000 DOT * $6 = $6,000.
Fast Fact: Liquidation thresholds are often based on the notional value of a position. If the market moves against your position and your margin falls below a certain percentage of the notional value, your position may be liquidated to prevent further losses.
What affects the notional value of a crypto perpetual contract?
Contract Size (Position Size)
Adding or removing leverage in an open contract can change the nominal value of the entire position. Since adding or removing leverage can increase and decrease the direct value of your contract size. For example,
If you have $100 and use 10x leverage, you control $1,000 worth of the asset.
If you have $100 and use 20x leverage, you control $2,000 worth of the asset.
Trading Price
The notional value of any crypto trade changes as the price of the asset fluctuates.
For example, if your contract size is 1,000 DOT and the price of DOT is $6, your notional value is $6,000. If the price of DOT spikes to $9 then the notional value changes to $9,000.
Type of crypto contract order
If you opt for cross-margin mode, all your available balance is used to prevent liquidation across all positions, which may impact the notional value differently compared to isolated margin mode, where each position’s margin is independent, keeping its notional value and risk isolated. This could be a potential risk management strategy
Wrapping Up
Understanding notional value is crucial for managing leverage, assessing market exposure, and ensuring effective risk management in perpetual futures trading.
It may seem like an underrated metric, but by using notional value mechanics you can optimally strategize your crypto contract trading.
