In this article, you will learn what does liquidated mean and how to avoid being liquidated. Liquidation in finance and economics is the process of bringing a business to an end and distributing its assets to claimants. It is an event that usually occurs when a company is insolvent, meaning it cannot pay its obligations when they are due. Liquidations are a common occurrence as the crypto market is in high volatility.
What does Liquidated mean?
In the context of cryptocurrency markets, liquidation refers to when an exchange forcefully closes a trader's leveraged position due to a partial or total loss of the trader's initial margin. It happens when a trader is unable to meet the margin requirements for a leveraged position (fails to have sufficient funds to keep the trade open.) Liquidation occurs in both margin and futures trading.
Trading with a leveraged position is a high-risk strategy, and it is possible to lose your entire collateral (initial margin) if the market makes a large enough move against your leveraged position. In fact, some countries like the United Kingdom consider it so risky it has banned crypto exchanges from offering retail investors leveraged trading products to protect novice traders from being liquidated and losing all their invested capital.
You can keep track of the percentage the market needs to move against your position it to be liquidated by using this formula:
Liquidation % = 100 / Leverage
For instance, if you use 5x leverage, your position will be liquidated if the price of an asset moves 20% against your position (100/5 = 20.)
How to avoid being liquidated
When using leverage, there are a handful of options available to mitigate the chances of being liquidated. One of these options is known as a “stop loss.”
A stop-loss, otherwise known as a “stop order” or “stop-market order” is an advanced order that an investor places on a crypto exchange, instructing the exchange to sell an asset when it reaches a particular price point.
When setting up a stop loss, you will need to input:
Stop price: The price where the stop loss order will execute
Sell price: The price at which you plan to sell a particular crypto asset
Size: How much of a particular asset you plan to sell
If the market price reaches your stop price, the stop order automatically executes and sells the asset at whichever price and amount stated. If the trader feels the market could move quickly against them, they might choose to set the sell price lower than the stop price so it's more likely to get filled (bought by another trader.)
Where to set a stop loss
When it comes to margin trading, risk management is arguably the most important lesson. Your primary goal should be to keep losses at a minimum level even before thinking about profits. No trading model is infallible. Therefore, you must deploy mechanisms to help you survive when the market doesn't go as expected.
Placing stop losses correctly is vitally important, and while there is no golden rule for setting a stop loss, a spread of 2%-5% of your trade size is often recommended. Alternatively, some traders prefer to set stop losses just below the most recent swing low (provided it's not so low you'd stand to be liquidated before it triggered).
Secondly, you should manage your trading size and the associated risk. The higher your leverage, the higher your chances of being liquidated. Using excessive leverage is akin to exposing your capital to unnecessary risk. Moreover, some exchanges manage liquidations ME Bitgressively, for aggressively. example, only allows traders to hold BTC as initial margin. This means if bitcoin's price falls, so too does the amount of funds held in collateral resulting in faster liquidations.
Due to the risk associated with leverage trading, some exchanges have moved to lower the limit traders can access. Both Binance and FTX are among the leading centralized crypto exchanges to slash leverage limits from 100x to 20x.
Bottom Line
Being liquidated would not be easy for both retail investors and traders. So, if you are trying leverage trading, you should know about liquidations and how to protect it. Here is what does liquidated mean and how to avoid being liquidated .
