What is Liquidation?

Key Points:

• Liquidation occurs when a trader's margin account balance falls below a certain threshold, known as the maintenance margin.
• Maintenance margin requirements vary depending on the exchange, the type of instrument being traded, and the trader's account level.
• Liquidation triggers a forced sale of the trader's open positions to cover the losses.
• Margin traders can prevent liquidation by actively monitoring their account balance, adding funds to their account, or reducing their leverage.

What is Liquidation?

Liquidation is a forced sale of a trader's open positions when their margin account balance falls below a predetermined threshold known as the maintenance margin. Maintenance margin requirements vary depending on the exchange, the type of instrument being traded, and the trader's account level. When a liquidation occurs, the trader's open positions are automatically closed at the current market price to cover any losses incurred.

Causes of Liquidation

Liquidation is typically triggered by a sudden and significant drop in the value of the margined asset. This can occur due to:

• Adverse market movements: Rapid price declines in the asset being traded can erode the trader's account balance, leading to liquidation.
• High leverage: Traders using higher leverage magnify both potential gains and losses. Leverage can exacerbate losses and trigger liquidation faster than trading without leverage.
• Insufficient account balance: If a trader's account balance is too low relative to their open positions, they may not have sufficient equity to cover losses and trigger liquidation.

Steps to Prevent Liquidation

Margin traders can take several steps to prevent liquidation:

• Actively monitor account balance: Traders should closely monitor their account balance and ensure they have sufficient equity to cover potential losses.
• Add funds to account: If the account balance approaches the maintenance margin, traders can add funds to their account to increase their equity and reduce the risk of liquidation.
• Reduce leverage: Lowering leverage reduces the potential losses and allows traders to maintain a higher maintenance margin level.
• Use stop-loss orders: Stop-loss orders can automatically close positions if the asset price reaches a predetermined level, limiting potential losses and preventing liquidation.

FAQsWhat happens if my account is liquidated?

• Your open positions will be closed, and you will be responsible for any losses incurred.

Can I still trade after liquidation?

• Yes, you can continue trading, but you may need to deposit more funds into your account to re-establish a positive balance.

How can I avoid getting liquidated?

• Actively monitor your account balance, add funds when necessary, and use appropriate leverage and stop-loss orders.

What is the difference between liquidation and margin call?

• Margin call is a warning that your account balance is approaching the maintenance margin. Liquidation occurs when you fail to meet the margin call by adding funds or reducing leverage.