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Liquidation occurs if an investor or trader no longer meets the margin requirements for leveraged positions.
A trading plan can help reduce the risk of making impulsive decisions when your funds are staked.
Strategies that can reduce the risk of liquidation when trading futures include trading simulations, risk management, and stop-loss orders.
Cryptocurrency derivatives allow traders to take advantage of market volatility and make maximum profits in a short period of time. But it should be noted that this type of trading can also quickly lead to losses. Unlike spot trading, derivatives trading does not involve directly trading the underlying assets, but is based on the estimated future value of those assets.
When a trader runs out of funds and cannot hold a leveraged position, liquidation occurs. In other words, if a trader can no longer trade because he has no funds, he no longer meets the margin requirements for leveraged positions, resulting in his position being liquidated. To avoid this, you need to have a strategy, especially if you trade futures with leverage.
In this article, we'll look at tools and strategies that can help reduce the risk of liquidation when trading futures.
Strategies to reduce liquidation risk
Due to the volatility of cryptocurrencies, even minor price fluctuations can lead to liquidation and loss of funds. Therefore, it is critical to employ thoughtful strategies to minimize risk.
Develop a trading plan
One of the most effective methods to reduce the risk of liquidation is to plan your trade in advance. This means planning not only for your income, but also for your exit options if the deal doesn't go as expected. By developing a trading plan and making informed decisions, you can avoid losing money due to liquidation.
A plan can reduce the risk of making impulsive decisions when your funds are staked. If you have a strategy, it will be easier for you to deal with emotions such as greed or fear. Often these emotions lead to unprofitable decisions: you hold a losing position too long or exit a profitable one too early.
The Binance Futures Calculator allows you to visualize potential trades by changing various parameters such as leverage, entry and exit prices, etc. With this tool, traders can calculate potential gains and losses in advance and take a more informed approach rather than following market fluctuations.
Protect your trading positions
Even if you take precautions, the market often moves unpredictably. In such cases, an exit strategy is important to help you avoid liquidating your position even if the market moves unfavorably for you.
Traders often look for a range or level at which they will exit a trade, but these are easy to miss. To make your exit plan more effective and minimize losses, it is recommended to use a stop loss order.
A stop loss order allows you to specify a specific price at which you will automatically exit the trade if the asset price reaches that price. While such orders are useful, it must be kept in mind that they do not guarantee complete protection against liquidation. The liquidation price can also vary, so a stop loss order may not always prevent it.
Keep an eye on your margin ratio
Margin ratio is an important factor that affects liquidation when trading futures. The margin ratio is calculated by dividing the maintenance margin by the margin balance. Maintenance margin is the minimum amount required in the account to keep a trade open, and margin balance is the total amount of funds in the account.
Therefore, the margin ratio is the maintenance margin divided by the margin balance. If the margin balance becomes less than the maintenance margin, the exchange will automatically close the trader's position to prevent further losses. Therefore, traders need to closely monitor their margin ratio to avoid liquidation.
If the price drops sharply, you need to maintain such a margin balance on the account that the ratio will be higher than the maintenance margin. The higher the balance, the lower the liquidation price.
Practice trading
If you're just starting to trade futures, it's important to take your time. To get used to and practice trading, create a Binance Futures demo account. Testnet is an exchange simulator where traders can practice trading cryptocurrency futures in real time without risking their funds.
Thanks to such services, you can get used to the platform and test your strategies without losing money. If you are already actively trading cryptocurrencies, use a trading simulator to test strategies and gain more experience.
Apply risk management strategies
Effective risk management is the key to safety when trading futures, especially if you are dealing in highly volatile assets, including cryptocurrencies. One of the main principles of risk management is to limit the risk on each trade. It is recommended to budget no more than 1-2% of your account balance on each trade as the amount you are willing to risk.
For example, if you have $10,000 in your account and want to trade futures, you can only risk $100-$200 on each trade. If the trade is unprofitable, you will only lose a small percentage of the amount in your account.
Take your time when you start trading with real money. When starting out, it is recommended to use a leverage ratio of 2x to 5x and avoid trading multiple contracts at once.
Occasional setbacks are inevitable, so you should avoid taking on a large position if one or two bad trades could completely ruin your finances. Start slow and build your trading strategy without worrying about managing large positions.
Avoid compounding losses
When trading futures, it is important not to increase your position on a losing trade. If you have already invested in a contract that is declining in value, do not invest additional funds in that contract.
If you put more money into a losing position, the liquidation price will go down and its risk will go up. Manage your risk by closing out losing positions rather than trying to make up losses by buying down stocks or adding more contracts. Make a trading plan and stick to it, avoiding impulsive decisions that can lead to serious losses.
Conclusion
Liquidation is a very important aspect of crypto futures trading. It is important for traders to understand what it is and how to avoid it. Although futures trading can be very profitable due to leverage, you need to know how this trade works and be able to minimize risks. Binance Futures recommends practicing responsible trading by following a trading plan and using take profit and stop loss orders to protect your assets and avoid unnecessary stress.
Additional Information
(Blog) How a liquidation order is executed: liquidation price and bankruptcy price
(Blog) What are stop orders in Binance Futures?
(FAQ) How to access the trading simulator on Binance Futures
Risk warning. Digital asset prices may be volatile. The value of the funds invested may go up and down. You may not get your invested funds back. You are solely responsible for your investment decisions. Binance is not responsible for your possible losses. Futures trading in particular is subject to high market risk and price volatility. If there is a sudden price change, there is a chance that your entire margin balance will be liquidated. Past performance is no guarantee of future performance. Before entering into a transaction, you should make an independent assessment of the appropriateness of the transaction, taking into account your own objectives and circumstances, including the risks and potential rewards. If necessary, contact your advisor. This information should not be considered financial or investment advice. To learn more about how to protect yourself, visit our Responsible Trading page. To learn more, please read our Terms of Use and Risk Disclosure.
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