You know, when the crypto market suddenly changes direction, analytical services immediately catch waves of liquidations. Hundreds of millions of dollars at a time. It’s interesting to understand how this actually happens and how not to become a victim of this mechanism.

It all starts with a simple idea: major exchanges allow traders to borrow money to increase their positions. Through margin trading, perpetual swaps, or futures, you can control much more capital than you have in your account. Sounds attractive, but it’s a double-edged sword.

When you take leverage, say 5x, and deposit $100 as collateral, you can open a position worth $500. If the asset’s price rises by 10%, you make $50 profit — which is already 50% of your collateral. Nice. But if the price drops by the same 10%, you lose your entire $100. And that’s where liquidations on exchanges begin — the system automatically closes your position when the collateral no longer covers the requirements.

I remember, in December 2023, Bitcoin plummeted by $3,000 in a single day. According to analytical services, at that moment, positions worth half a billion dollars were liquidated. Most traders held long positions, betting on a rise. They were wrong.

The formula is simple: with 5x leverage, a position gets liquidated if the price moves against you by 20% (100 divided by 5). It’s math, and there’s no getting around it.

How to protect yourself? The first and most important thing — a stop-loss. This is an order you set in advance, and if the price drops to a certain level, your position automatically closes. You decide how much you’re willing to lose.

Here are two examples. Scenario one: $5,000 in your account, but you only use $100 as collateral with 10x leverage. The position is $1,000, with a stop-loss 2.5% below entry. Maximum loss — $25, which is 0.5% of the deposit. Without a stop-loss, the position gets liquidated at a 10% drop.

Scenario two: the same $5,000, but collateral is $2,500 with 3x leverage. The position is $7,500, with a 2.5% stop-loss below entry. Loss of $187.5 — which is 3.75% of the deposit. See? Even lower leverage can lead to bigger losses if the position is larger.

The main thing — don’t get fixated on the size of leverage. More important is the size of the position itself and the stop-loss. Liquidations on exchanges happen not because a trader chose 5x instead of 3x. They happen because the person didn’t plan an exit and didn’t set up protection.

Risk management — it’s not boring theory. It’s what separates long-lasting traders from those who blow their deposit in a month. Think of a plan B before opening a position. The market doesn’t always go in the direction you expect.