Recently, there have been many small-cap stocks, often with funding rates maxed out, and the funding rate changed to 1 hour. At that time, I didn’t understand why this situation occurred. Moreover, I observed that when many small-cap stocks surged sharply, this situation would arise. After studying the principle carefully, I found it quite interesting, and I summarized a relatively reliable trading method... Now I will share it with all of you for discussion.
1. The Relationship Between Open Interest and Price
Open Interest Increase and Price Trend: When the price rises and open interest increases simultaneously, it indicates that capital continues to flow into the market, intensifying the divergence between long and short positions, and the original trend may continue.
If the price declines accompanied by an increase in open interest, it reflects that short positions dominate the market, and there may be further short-term declines, but excessive selling may trigger a reversal.
Signal of Decreasing Open Interest: A reduction in open interest usually indicates that capital is leaving the market. If there is a price anomaly at this time (such as a rapid increase), it may be a short-term rebound caused by short sellers passively closing positions, with weaker trend sustainability.
2. The Interaction Between Funding Rates and Price
Adjustment Mechanism of Funding Rates: The funding rates for perpetual contracts are used to anchor the contract price to the spot index price. When the contract price is higher than the spot price, the funding rate is positive, and longs must pay shorts; conversely, shorts pay longs.
High positive funding rates may attract arbitrageurs to short contracts to gain funding rate profits, thus suppressing further divergence of contract prices from the spot price.
Warning Signal of Extreme Funding Rates: Long-term high positive funding rates may indicate that the market is overly bullish, with a risk of correction; persistent negative funding rates may reflect a short-seller dominance, but may trigger a rebound from short position liquidations.
3. The Impact of the Relationship Between Open Interest and Funding Rates on Price
Surge in Open Interest and Divergence in Funding Rates: If open interest rises rapidly and the funding rate significantly deviates from neutral (such as excessively high positive funding rates), it may indicate that market sentiment is overheated, increasing the risk of price volatility. At this time, one should be cautious of violent fluctuations caused by long and short position liquidations.
Phase Balance Between Open Interest and Funding Rates: When open interest is stable and funding rates are close to neutral, it indicates that the market has entered a short-term equilibrium state, and prices may exhibit narrow fluctuations.
In the above figure, special attention should be paid to the third situation, which indicates that a short squeeze is occurring, and there is still an opportunity for long positions, but the risk is also increasing.
