What is Forced Liquidation?
Forced liquidation refers to when an exchange forcefully closes a trader’s leveraged position due to a partial or total loss of the trader’s initial margin. This often happens when a trader is unable to meet the margin requirements for a leveraged position. That is, they don’t have sufficient funds to keep the trade open. Liquidation occurs in both margin and futures trading.
Using a leveraged position (essentially borrowing money to place an order) in margin or futures trading is highly risky and it is possible to lose your entire collateral if the price moves too far away from your target.
Trading With Leverage
Leveraged positions are likely to have volatile price swings which may cause a trader’s investment to fall into negative balance almost immediately. In such situations, losses could be larger than the maintenance margin. Which makes the losers liquidated. This process is involuntary and automatic.
Forced liquidation occurs when the investor or trader is unable to fulfil the margin requirements for a leveraged position. When you’re trading with leverage, the liquidation price is something you’ll need to watch closely. The higher the leverage you use, the closer the liquidation price is to your entry.
Forced liquidation typically includes an additional liquidation fee. This fee varies with each platform. It exists to incentivize traders to manually close their positions before they’d have to be automatically liquidated. Many trading platforms will allow you to calculate your liquidation price before entering a position.
Binance Futures has a helpful calculator that lets you calculate your PnL (Profit and Loss), target price, and liquidation price in advance.
Tips to Avoid Liquidation
There are 3 ways to avoid getting liquidated:
Adding funds to increase your margins, setting stop loss and applying leverage more responsibly.
Traders can increase their margin as the position gets closer to 100%. They can do this by monitoring their initial deposit (margin), and comparing it with the price movement, and adding funds to increase the margin so that the position does not get to the point of liquidation. Doing this leads to effectively reducing the leverage taken.
Traders can also apply stop-loss orders which allow them to set a price to sell off automatically when the price of an asset falls to or beyond this predetermined price. This feature is available on all futures exchange platforms
Even if you may still lose some funds, the stop loss tool will protect you from losing everything in trade and from having to pay a liquidation fee.
The most effective way to prevent liquidation is to apply leverage responsibly. Leverage has a big impact on the longevity of a trade. While it’s attractive to use large amounts of leverage, lower amounts of leverage will always be a safer route. High use of leverage could lead to major wins but could also magnify your losses.