LIQUIDATION: What It is and How to Avoid Getting Rekt on Major Crypto Exchanges

In crypto futures trading, losing positions are forced to exit to prevent traders from falling into negative equity. Leveraged positions are prone to volatile price swings which may cause a trader's investment to plunge into negative balance almost instantaneously.

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In recent weeks, two major crypto exchanges, Binance and FTX, have had to lower the amount of leverage that traders can take up. This follows pressure from authorities, with claims that high leverages across derivative products like futures and options are causing many traders to lose their funds.

In crypto futures trading, losing positions are forced to exit to prevent traders from falling into negative equity.

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SEE ALSOWhy Major Exchanges Are Cutting High Leverages to Just 20x

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Leveraged positions are prone to volatile price swings which may cause a trader’s investment to plunge into negative balance almost instantaneously.

In such situations, losses can be larger than the maintenance margin. As a result, the losers are liquidated. This process is involuntary and automatic if a trade meets specific price criteria. 

Let’s say you were to open a trade with $100, and with a leveraged position expecting the BTC price to increase (long). The leverage you took up is 20x, making your position worth $2,000.

If the price of BTC were to drop only 5%, you would completely wipe out the initial margin of $100. If you cannot fulfill the margin call demands to keep the trade afloat, your position is now at risk of liquidation.

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Tips to Avoid Liquidation

There are basically 2 ways to avoid getting liquidated:

  • Adding funds to increase your margins
  • Applying leverage more responsibly

Traders can apply more margin as the position gets closer to 100%.

This involves 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 is effectively reducing the leverage taken.

With liquidation set to happen at 100% of a trader’s initial deposit, traders rely on specific margin ratios depending on the margin they take. From the example trade, by taking a 20x leverage, the margin ratio reduces from 100% in the initial deposit to 5%.

Traders can also apply stop loss orders which allow them to set a price to sell at automatically should the price of an asset fall to or beyond this predetermined price. This feature is available on all futures exchange platforms.

Although you may still lose some funds, the stop loss tool will protect you from losing everything on a trade and from having to pay a liquidation fee.

The most effective route to prevent liquidation is to apply leverage responsibly. Leverage has a significant impact on the longevity of a trade. While it may be enticing to use large amounts of leverage, lower amounts of leverage will always be a safer route.

High use of leverage can indeed lead to major wins. However, it could also magnify your losses.

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RECOMMENDED READING: How to Invest in Bitcoin Futures Contracts Trading

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