What does liquidation mean? Why would one be liquidated? How to avoid being liquidated while investing and trading? 【Newbie Investment Trading Tips】

During periods of severe market fluctuations, a single misstep can quickly lead to the evaporation of your principal and even result in losses — this is the frightening “liquidation.” It can not only cause you to lose all your funds, but also leave you in debt! How does liquidation occur? Why is high leverage particularly dangerous? And how can you timely implement a stop loss to avoid significant losses? This article will provide a comprehensive analysis to help you protect your hard-earned money!

What does liquidation mean? Why would it be liquidated?

“Liquidation” refers to the situation when you incorrectly judge the market direction and incur losses to the point where your margin is insufficient. In simple terms, when the market trend is contrary to your expectations and your funds (net value) fall below the minimum margin threshold required by the trading platform, the system will automatically forcefully close all your positions, giving you no chance to turn things around. This situation is called “liquidation.”

Why will I be liquidated?

• Your trading direction is opposite to the market trend.
• The loss amount exceeds the margin (equity is below the maintenance margin)

Beware of these operations that are prone to liquidation!

1. Excessive leverage

Excessive leverage is the most common cause of liquidation. Leverage trading is like a double-edged sword; while it can amplify profits, the risks also increase exponentially. For example, if you use 100,000 yuan of capital to operate a financial product with 10x leverage, it is equivalent to operating a position of 1,000,000 yuan. At this time, if the market moves in the opposite direction by 1%, your capital will lose 10%; if the market fluctuates in the opposite direction by 10%, you may face a total loss of margin, be required to provide additional margin to the point of questioning life, and even encounter the predicament of liquidation.

Many investors initially believe they can control risks, but market fluctuations often occur faster and more violently than expected. It is recommended that everyone carefully assess when operating and not let leverage become a stumbling block on the investment path.

2. Stubborn mentality, unwilling to take a loss

This is also one of the common mistakes retail investors make, holding onto the hope that “it will rebound soon…”. As a result, when faced with a significant gap down in the market, Gate directly liquidates at market price at the opening, causing losses far beyond expectations.

3. Ignoring Hidden Costs

Common operations include: day trading not closed, for example forgetting to leave a position requiring additional margin, and being forcibly liquidated the next day due to a gap. Or for option sellers, encountering a surge in volatility (such as significant political events), margin requirements suddenly double.

4. Insufficient Liquidity Trap

When trading in illiquid assets or during unconventional hours, it's easy to encounter excessive bid-ask spreads and outrageous stop loss execution prices. For example, if you originally wanted to set a stop loss at 100, but the market only has buyers willing to take the order at 90.

5. Black Swan Event

For example, during the global pandemic in 2020 and the Russia-Ukraine conflict, in situations of consecutive price drops, it may be impossible for trading platforms to close positions in a timely manner. Exhaustion of margin could lead to debts and the risk of liquidation.

The Liquidation Risks of Different Assets

The risk of liquidation varies significantly among different investment products! Newcomers to the market need not be overly anxious; not all investments will leave you with nothing overnight. Choosing the right assets and strategies is key to investing with peace of mind.

cryptocurrency liquidation

Due to the dramatic market fluctuations, cryptocurrencies can be said to be in a high-risk area for liquidation. There have been instances where Bitcoin has fluctuated by 15% in a short period of time, leading to the majority of investors across the network experiencing liquidation. It is worth noting that when cryptocurrency investments face liquidation, not only will the margin be completely lost, but the coins you purchased will also disappear.

foreign exchange liquidation

Forex margin trading is a typical game of operating with small capital to control large funds! Many Taiwanese investors like to use leverage in forex trading because it allows them to enter the market with less margin. However, before discussing liquidation, beginners need to understand the following concepts:

There are three types of contract sizes:

• Standard Lot: 1 Lot
• Mini Lot: 0.1 Lot
• Micro lot: 0.01 lots (most suitable for beginners to practice)

Margin Calculation Method:

Margin = ( Contract Value × Number of Contracts ) ÷ Leverage Multiplier

For example: Suppose we place an order of 0.1 lots of a currency pair using 20x leverage (assuming a value of 10,000 USD)

➤ Required margin = 10,000 ÷ 20 = 500 USD

When the available margin ratio in your account falls to the minimum level set by the platform (usually 30%, please confirm the specific regulations of each trading platform), the platform will execute liquidation, commonly known as “forced closing”.

For example: an account balance of 500 USD but has lost 450 USD, leaving only 50 USD in the account. The system will automatically Close Position, which is a case of liquidation.

Stock liquidation

1. Spot trading “will not” be subject to liquidation

Buying stocks (using 100% own funds) is the safest option; even if the stock price drops to zero, you only lose your principal and won't owe any debt to the trading platform.

2. But “financing” and “day trading” may encounter liquidation!

• Margin buying stocks (borrowing money from the trading platform): If the maintenance ratio falls below 130%, a “margin call notification” will be received. If the funds are not replenished, it will result in liquidation (for example, using 600,000 to buy 1,000,000 worth of stocks, if the stock price drops by about 20%, it will reach the margin call standard).

• Day trading failure (unable to close on the same day and becomes a position): If the opening price the next day drops to the limit and cannot be sold, the platform will directly liquidate the position, and if the margin is insufficient, it will be forcibly liquidated.

Advice for super newbies:

1️⃣ Start practicing with “spot stocks”: use idle funds to buy stocks, at least you won't wake up one day to find yourself in liquidation.

2️⃣ Stay away from “leveraged products”: Futures, contract trading, and other high-risk products should be attempted only after gaining sufficient experience.

3️⃣ Adopt a conservative strategy: Regular fixed investment is a hundred times safer than full position trading.

If you still want to try contract trading:

1️⃣ Start with micro lots: Try 0.01 lots to slowly familiarize yourself with the market.

2️⃣ Use leverage cautiously: Beginners are advised to keep the leverage ratio below 10 times.

3️⃣ You must set a stop loss: Never go against the market!

How to Use Risk Management Tools to Prevent Liquidation

Risk management tools are like a lifeline in trading, helping you more effectively control the timing of your exit, set stop loss and take profit levels, and avoid significant losses when the market suddenly reverses. There are various tools available on the market, and next, I will introduce which features are the most practical.

stop loss and take profit

“stop loss ( SL )” is to set an “automatic liquidation price”, when the stock price drops to the price you set, the system will automatically sell for you, preventing losses from continuing to expand. Conversely, “take profit ( TP )” is to set an “automatic profit price”, when the price rises to the target price, it will automatically sell to realize profits. These two functions are extremely important as they can help you effectively control risks and avoid significant losses at once!

As for the risk-reward ratio, in simple terms, it means “profits should be greater than potential losses to be worthwhile.” A lower ratio indicates that the trade is more attractive, like risking 1 unit to earn 3 units, where the risk is lower and the returns are more stable.

Risk-Reward Ratio = (Entry Price - Stop Loss Price) / (Take Profit Price - Entry Price)

How to determine the levels for stop loss and take profit?

Experienced traders often set stop loss and take profit based on technical indicators such as support and resistance lines, moving averages (MA), etc. If you are a beginner just starting out, you can use a simple and straightforward “percentage method”, for example, setting it at 5% above and below the purchase price, so you don't have to be on edge all day watching the market; stop loss when it's time to stop loss, take profit when it's time to take profit, simple and clear!

Negative Balance Protection

Under regulatory requirements, the negative balance protection mechanism is a safety measure that trading platforms must provide for all users engaging in leveraged trading. In short, this means that you will only lose the funds in your account at most and will not owe any debt to the trading platform. Even if you do incur losses to the bottom, the remaining losses will be borne by the platform itself. However, some brokers lower the available leverage multiples proactively before encountering major market movements in order to avoid the huge risks brought by high leverage. This protection mechanism is mainly designed to take care of novice investors, allowing beginners some room for mistakes.

Investing has its gains and losses. Investors should be more cautious when engaging in leveraged trading to avoid the risk of their accounts being wiped out. Before conducting any trades, it is crucial to fully understand trading knowledge and effectively utilize risk management tools to set stop loss and take profit ranges, which will benefit long-term investment planning.

Frequently Asked Questions

What is the difference between liquidation and forced liquidation?

The basic concepts of liquidation and forced liquidation are similar, and many investors view the two as the same situation. To break it down, the slight difference is that forced liquidation usually only incurs losses up to a specific ratio, which may vary slightly depending on the available margin ratio set by each trading platform. On the other hand, liquidation refers to when the market price experiences a gap that causes the platform to be unable to react in time, resulting in the complete depletion of margin, and may even require additional borrowing. Therefore, liquidation can be equated with forced liquidation, but forced liquidation is not completely equivalent to liquidation; however, nowadays, investors generally consider the two to be the same situation.

What is the difference between Close Position and liquidation? ###

Close Position is when investors choose to end their positions based on stop loss or take profit prices, while liquidation occurs when severe market fluctuations lead to insufficient margin for investors, causing the trading platform to forcibly close their positions.