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Highlights
Traders experience liquidation when they are unable to meet the margin requirements for a leveraged position.
A trading plan can decrease the chances of having to make impulsive decisions when your funds are at stake.
Mock trading, risk management strategies and stop-loss are some of the strategies to minimize liquidation risks in the futures market.
Cryptocurrency derivatives allow traders to take advantage of market volatility to increase their profits in a short time. However, this type of trading is a double-edged sword, as it can also result in losses just as quickly. Unlike spot trading, derivatives do not involve assets directly, instead they are based on speculation of the future value of an underlying asset.
A liquidation occurs when traders cannot maintain a leveraged position because they do not have enough funds. In this sense, traders suffer liquidation when they cannot meet the margin requirements necessary for a leveraged position, that is, they do not have sufficient funds to keep their trades open. For this reason, it is very important to adopt a strategy, especially when trading with leverage in futures.
In this article, we look at the different tools and strategies that can be used to minimize liquidation risks in futures trading.
Strategies to minimize liquidation risks
Due to the intrinsic volatility of cryptocurrencies, even small variations in prices can result in liquidation and loss of funds. Therefore, it is extremely important to apply smart strategies and minimize liquidation risk.
Develop a trading plan
Advance trade planning can be the most efficient approach to reducing the chances of a liquidation. It involves not only planning for profits, but also having an exit strategy in case a trade does not go as expected. Preparing a trading plan and adopting a prudent approach will decrease the possibility of incurring losses due to liquidation.
Additionally, having a plan reduces the likelihood of making impulsive decisions when your funds are at stake in the market. A strategy can help prevent emotions like greed or fear from guiding your actions by eliminating the temptation to hold a losing position for too long or exit a profitable position too soon.
The Binance Futures Calculator allows you to visualize possible trades by testing different parameters, including leverage, entry price, exit price, and more. With this tool, traders can calculate expected profits or possible losses in advance, and with this information they can follow a more planned approach instead of getting carried away by market movements.
Secure your trading positions
Despite taking necessary precautions, markets often move in undesirable directions. In these cases, it is essential to have an exit strategy that prevents your position from being liquidated if the markets move in the opposite direction to your operation.
Often, traders take note of the range or level at which they should exit a trade, but then fail to take it into account. To make your exit plan more effective and reduce possible losses, it is usually recommended to use a stop-loss order.
A stop-loss order determines the specific price at which a trade will be automatically closed if the asset's price reaches this predetermined level. While stop-loss orders can be useful, it is necessary to keep in mind that they are not guaranteed protection against liquidation. The settlement price may fluctuate and a stop-loss order will not prevent settlement.
Look at the margin rate
The margin rate is a fundamental factor that can affect settlement in futures trading. The margin rate is calculated by dividing the maintenance margin by the margin balance. The maintenance margin is the minimum amount required in the account to keep the trade open, while the margin balance is the amount of funds available in the account.
Therefore, the maintenance margin divided by the margin balance determines the margin rate. If the margin balance falls below the maintenance margin rate, the exchange will automatically close the trader's position to prevent further losses. It is for this reason that traders must closely monitor their margin rates to avoid liquidation.
In the event of a price drop, it is very important to have enough margin balance in the account to keep the margin rate above the maintenance margin rate. The higher the margin balance, the lower the settlement price.
Practice trading
If you are new to futures trading, go slow and be consistent. A good way to do this is to start with a demo account to practice futures trading on Binance Futures. The testnet environment offers a simulated trading platform to practice in real-time cryptocurrency futures markets without risking capital.
Services like this allow you to familiarize yourself with the platform and test your trading strategies without risking real money. Active cryptocurrency traders can also use Mock Trading to test new trading strategies and tools and thus gain more experience.
Use risk management strategies
Effective risk management is essential when trading futures, especially when dealing with volatile assets such as cryptocurrencies. One of the basic principles of risk management is to limit your exposure in any trade. It is recommended not to risk more than 1 or 2% of your trading account balance in a single trade.
For example, if you have a trading account with $10,000 and plan to trade futures, you should only risk $100 to $200 per trade. If this trade goes wrong, you will only lose a small part of your account balance.
When you start trading with real funds, take your time. In the beginning it is best to use 2x to 5x leverage and avoid trading multiple contracts at once.
Occasional hiccups are inevitable, so you should avoid trading large positions, where just one or two bad trades could destroy you financially. Rather, start small and develop a trading methodology without the added pressure of having to manage larger positions.
Avoid accumulation of losses
When trading futures, it is important to avoid increasing your position on losing trades. If you have already invested in a contract and its value falls, you should not invest more in that same contract.
Increasing a losing position will lower the liquidation price and increase the chances of a liquidation. Traders should prioritize risk management and reduce losses by closing losing positions, and not try to reduce them by averaging down or adding more contracts. It is essential to prepare a trading plan and follow it to the letter to avoid making impulsive decisions that could lead to significant losses.
In conclusion
Settlement is a very important aspect of cryptocurrency futures trading, so traders must understand what it entails and how to avoid it. Although futures trading can be very profitable due to the leverage it offers, traders must understand how it works and how to minimize the associated risks. Binance Futures recommends responsible trading by properly planning trades and using take-profit and stop-loss orders to protect investment capital and reduce stress.
Further reading
How a Liquidation Order is Executed: Liquidation Price vs. Liquidation Price bankruptcy price
What are stop orders on Binance Futures?
How to access simulated trading on Binance Futures
Risk warning: Digital asset prices can be volatile. The value of your investment could increase or decrease, and you may not get back the amount invested. You alone are responsible for your investment decisions and Binance is not responsible for any losses you may incur. Futures trading, specifically, is subject to high market risk and price volatility. Your entire margin balance could be liquidated in the event of extreme market movements. Past performance does not guarantee future performance. Before trading, you should make an independent assessment of the suitability of the transaction in light of your own objectives and circumstances, including the risks and potential benefits. If applicable, consult your advisors. This information should not be construed as financial or investment advice. For more information on how to protect yourself, visit our Responsible Trading page. Please read our Terms of Use and Risk Warning for more details.
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