The funding rates are one of the most popular and successful indicators for Bitcoin derivative traders. The funding rates show whether the majority of the traders are either longing or shorting Bitcoin and this ratio can be very beneficial to any trading strategy.
The funding rates are periodic payments made by traders with an open position, long or short. Depending on the funding rate the trader who is in a position has to pay after a certain period (mostly 8 hours or daily) a fee. This fee could be positive as well so that the trader with a position is receiving a reward for having their position open. The funding rates are there to maintain a balance between the number of traders that are long and short.
When for example 60% of the traders are long on Bitcoin then there is a positive funding fee and the contracts that are in a long position have to pay a funding fee to the contracts that are in a short position. This generally encourages traders to open a short position.
The same works the other way around, when let's say 65% of the contracts are shorting Bitcoin then we have a negative funding rate and the shorts are paying the longs.
This funding rate can give a good view of the short-term sentiment of the markets. When the majority is short, funding rates are negative, so the majority is expecting the price to drop.
The funding fees can vary across different exchanges and can therefore be very confusing at times. You could see for example positive funding on Binance on USDT contracts and negative funding on Bybit on BTC settled contracts. That is why Whaleportal introduced the “average funding fee”. This number is calculating the average fee's across the most important exchanges and contracts. Therefore the traders get an even better perspective on the short-term sentiment.
The funding rates are a great reflection of the market sentiment and therefore we can use this metric in our trading strategy. If there is an extreme reading in the funding rates it often indicates caution for the opposite direction. For example, if the funding rates are extremely negative, it wouldn't be a great moment to open a short position but rather look for evidence in the chart to check for a long position. We often see a quick bounce after an extreme reading of negative funding rates in the short term to restore the balance. In that way the funding rates can act as a direct signal for price prediction, however, it also works over a longer period. Often when we see negative funding over a longer period, the price tends to trend upwards.
Similar to a longer period with positive funding rates the price tends to trend downward afterward. Do take in mind that negative or positive funding rates can maintain for an extended period and therefore should never be used as a sole indicator but rather as a metric combined with other metrics (e.g. breakouts, price channels, patterns, on-chain statistics, etc.)
Funding rates can also be used from an investment point of view, one of the hardest things to determine is when we flip from a bull to a bear market or the other way around. Historical data shows that funding rates are extremely reliable signs for this specific case because when Bitcoin has topped out in a bull market one of the first signals traders can get to spot the beginning of the bear market is to see whether price declines during periods of negative funding.
This also works in the shift from a bear market into a bull market. When price continues to rise during periods of positive funding, it shows that there is strong momentum for buyers and that we're likely not in a bear market anymore.
Generally, when the funding fee is negative, the price tends to trend up; when the fee is positive, the price tends to trend downwards. The more extreme the funding fee reading the higher the odds that were going in the opposite direction.
You should use this metric with other indicators to be more certain of a scenario playing out. Also, the funding fee can be misleading during changing market conditions. Always make sure to view the historic funding fee and compare it with the price action to see how the price behaved in the past weeks or months during similar times of funding fees.