To prevent the possibility of liquidation, you should make sure you have a careful trading strategy in place before starting any leveraged positions. In this article, we will discuss, Bitcoin liquidation. And how to avoid liquidations?
What Does Bitcoin Liquidation?
Liquidation, in general, is the process of converting an asset into cash. In the world of crypto trading, however, it has a slightly different meaning.
A crypto exchange may occasionally forcefully close a trader's leveraged position when the price of a crypto asset decreases. When a trader doesn't have enough funds to keep a leveraged trade open, this happens. As a result, they cannot meet the margin call, Which is one of the risks associated with margin trading.
If the market moves against your leveraged position to a large degree, you may lose your entire collateral (or “initial margin”) and your position could be liquidated. In other words, your initial capital input will be surrendered to the exchange.
How to Avoid Liquids
You have a number of strategies at your options when trading with leveraged positions that might reduce the risk of liquidation. A stop-loss order is among the most well-known and effective trading strategies. Effectively, the exchange can close your position at a predetermined time, thereby saving you from bigger losses in the event that liquidation becomes necessary. Consider a stop-loss as an emergency break; if the market moves too far in your position's favor, you have a built-in fail-safe to limit further losses.
stop order
It is an order that you can put through a crypto exchange, sometimes known as a "stop loss" or a "stop-market order," directing the exchange to sell an asset when its price reaches a certain level. As such, it is an essential piece of risk management for leveraged trading.
You'll need to be clear of your stop price, the sell price, and the amount of the order as well as the price at which the order will take effect (how much of the asset you want to sell). The exchange will automatically Carry out your order and sell the specific amount at the specified price if the asset reaches the stop price.
Stop losses are meant to decrease your potential losses, as you've probably guessed by this point. Although there is no established rule for where to place a stop loss, it is typically advised to place one between 2% and 5% of your transaction size. You should also aim to limit your per-trade losses to 1.5% or less of your total account size.
Manual margin ratio monitoring
The following formula can be used to manually keep track of your losses if you don't want to use a stop order. You'll need to know what percentage the market must move against your position in this case for it to be liquidated.
Liquidation % = 100 / Leverage
We'll explain it with an actual trading example. Consider that you are creating a position with a $100 initial margin and a 4X leverage to create a $400 position. It seems as follows using our formula:
25% = 100 / 4
As you can see, if the asset's price changes by 25% against your position, you risk being liquidated. In this case, liquidation would take place if your $400 holding dropped to $300 in value.
While you can keep track of this manually to ensure that you exit before that happens, stop orders can be a much more efficient and safer way to monitor your positions and mitigate risk.
Hopefully, reading this article, "What Does Bitcoin Liquidation? How to Avoid Liquidations?" can help you to understand it better.
