Six Strategies to Minimize Liquidation Risks in Crypto Futures
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Traders experience liquidation when they cannot meet the margin requirements for a leveraged position.
A trading plan can lessen the likelihood of being forced to make impulsive decisions when your funds are at stake.
Mock trading, risk-management strategies, and stop-losses are some of the strategies to minimize liquidation risks in the futures market.
Cryptocurrency derivatives allow traders to leverage volatility in the market to maximize profits in a short amount of time. However, this type of trading is a double-edged sword since it can also result in losses just as quickly. Unlike a spot trade, derivatives do not involve assets directly and are instead based on the speculated future value of an underlying asset.
Liquidation occurs when traders cannot maintain a leveraged position due to insufficient funds. As such, traders experience liquidation when they cannot meet the margin requirements necessary for a leveraged position, i.e., they do not have sufficient funds to keep their trades open. This is why having a strategy in place is crucial, especially when trading with leverage in futures.
In this article, we look at the different tools and strategies you can use to minimize liquidation risks in futures trading.
Strategies to Minimize Liquidation Risks
Due to the volatile nature of cryptocurrencies, even slight price variations can lead to liquidation and a loss of funds. Thus, it is imperative to apply smart strategies and minimize liquidation risk.
1. Develop a trading plan
Planning trades ahead of time can be the most effective approach to decrease the possibility of liquidation. This includes not only planning profits but also having an exit strategy in case a trade does not go as expected. Developing a trading plan and taking a measured approach will lessen the chance of incurring losses due to liquidation.
Having a plan lessens the likelihood of making impulsive decisions when your funds are at stake in the market. A strategy can help prevent emotions, such as greed or fear, from guiding your actions by removing the temptation to retain a losing position for too long or exit a profitable one too soon.
The Calculator tool on Binance Futures allows you to visualize potential trades by experimenting with different parameters, including leverage, entry price, exit price, and more. By using this tool, traders can calculate their expected profits or potential losses ahead of time, enabling them to follow a more planned approach rather than being driven by market movements.
2. Secure your trading positions
Despite taking necessary precautions, the markets often move in unintended directions. In such cases, it is vital to have an exit strategy that prevents your position from getting liquidated if the markets move in the opposite direction to your trade.
Often, traders take note of the range or level at which they would exit a trade, but these can be disregarded too easily. To make your exit plan more effective and mitigate potential losses, it's often advisable to employ a stop-loss order.
A stop-loss order establishes the specific price at which a trade will be exited automatically if the asset's price reaches this predetermined level. Although stop-losses can be helpful, it is necessary to understand that they are not a guaranteed safeguard against liquidation. Fluctuations in the liquidation price may occur, and a stop-loss order may fail to prevent liquidation.
3. Watch the margin ratio
The margin ratio is a critical factor that can affect liquidation in futures trading. The margin ratio 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.
Hence, the maintenance margin divided by the margin balance determines the margin ratio. If the margin balance falls below the maintenance margin rate, the exchange will automatically close out the trader's positions to prevent further losses. Therefore, traders need to monitor their margin ratio closely to avoid getting liquidated.
In case of a price drop, it is essential to maintain enough margin balance in the account to keep the margin ratio above the maintenance margin rate. The higher the margin balance, the lower the liquidation price.
4. Practice your trading
If you're new to trading futures, taking it slow and steady is important. One way to do this is by starting with a demo account to practice futures trading on Binance Futures. The Testnet environment provides a simulated trading platform enabling traders to practice in real-time cryptocurrency futures markets without risking their capital.
Services like this allow you to familiarize yourself with the platform and test your trading strategies without risking real money. Active crypto traders can also use Mock Trading to test new trading strategies and tools to gain more experience.
5. Use risk management strategies
Effective risk management is crucial in futures trading, especially when dealing with volatile assets such as cryptocurrencies. One of the key principles of risk management is limiting your exposure on any given trade. It is recommended never to risk more than 1-2% of your trading account balance on a single trade.
For example, if you have a trading account with a balance of $10,000 and are planning to trade futures, you should only risk between $100 to $200 per trade. If this trade goes wrong, you will only lose a small portion of your account balance.
Take your time once you start trading with real funds. When just beginning, it's best use a leverage of 2x to 5x and avoid trading multiple contracts at once.
Occasional drawbacks are inevitable, so you should avoid establishing a large position where just one or two bad trades could wipe you out financially. Instead, start slow and develop a trading methodology without the added pressure of managing larger positions.
6. Avoid compounding losses
While trading futures, it's important to avoid increasing your position in a losing trade. If you've already invested in a contract and its value decreases, you should not invest more in that same contract.
Adding to a losing position will lower the liquidation price and increase the chance of getting liquidated. Traders should focus on risk management and cut their losses by closing out losing positions instead of trying to mitigate them by averaging down or adding even more contracts. It's essential to establish a trading plan and stick to it, avoiding impulsive decisions that could lead to significant losses.
Liquidation is a critical aspect of crypto futures trading, and traders must understand what it entails and how to avoid it. Although trading futures can be highly profitable due to the leverage it provides, traders need to know how it works and how to minimize associated risks. Binance Futures recommends practicing responsible trading by implementing a proper trading plan and using take-profit and stop-loss orders to protect investment capital and alleviate stress.
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