What is liquidation?
Liquidation is a common situation in financial transactions. Its traditional meaning refers to the process of involuntary conversion of assets into cash or cash equivalents (stablecoins). This is a market mechanism used to exit leveraged positions. When traders cannot meet margin requirements, forced liquidation will automatically occur. But in contract trading, forced liquidation is something you must do everything you can to avoid.
Binance Exchange - the world's largest Bitcoin exchange, register to receive a 20% commission rebate.
Binance: Click on the Binance registration link, referral code XSGEK3VL
Binance registration: https://www.binance.com/zh-CN/join?ref=XSGEK3VL (20% commission rebate) or refer to the Binance registration tutorial. Spot contracts are automatically rebated 20% every hour.
In cryptocurrency trading, forced liquidation usually occurs in futures or margin trading. When an investor or trader's account cannot meet the maintenance margin requirements, the trading platform will automatically sell its holdings to make up for losses or repay borrowings. The purpose of this is to prevent the account balance from becoming negative and to ensure the interests of the platform and other traders.
The forced liquidation process can be slow or fast, depending on the rules of the exchange and the leverage used in the trade. In the case of low leverage, it may take a large price movement to trigger a forced liquidation. However, in the case of high leverage, even small price changes may lead to forced liquidation, which increases the risk for traders.
Why is there forced liquidation?
When a trader is unable to meet the margin requirements of a leveraged position due to insufficient funds in his account, a forced liquidation will occur. In order to avoid forced liquidation, traders need to reasonably set leverage ratios, set stop-loss prices, and pay close attention to market fluctuations.
Traders may be forced to close their positions for the following reasons:
1. Insufficient margin: When the trader's account balance cannot meet the maintenance margin requirement, a forced liquidation will be triggered. The maintenance margin requirement refers to the ratio between the margin balance and the position value. If this ratio is lower than the minimum requirement set by the exchange or platform, a forced liquidation will be triggered.
2. High leverage trading risk: Leveraged trading increases traders' profit opportunities, but also increases the risk of loss. If traders use too high a leverage ratio, even a small price fluctuation may result in insufficient account funds to meet the maintenance margin requirements, thereby triggering forced liquidation.
3. Market volatility: Violent fluctuations in market prices may cause traders’ positions to be in a loss state, which in turn may result in insufficient account funds to meet maintenance margin requirements. Especially in high-leverage transactions, price fluctuations may quickly cause traders’ account funds to fall into negative values, thus triggering forced liquidation.
4. Operational errors: Traders may suffer position losses due to operational errors or wrong judgments, which may trigger forced liquidation. For example, setting an unreasonable stop loss price or failing to close the stop loss in time may lead to an increase in position losses and ultimately lead to forced liquidation.