Recently, many beginners have been frightened by liquidation. Actually, a lot of the time it happens because they don’t have a correct understanding of risk. Today, let’s talk about the thing that can wipe people out in a single night—how liquidation happens in the first place.

Simply put, liquidation occurs when you bet the wrong direction in your trade. When your losses eat through even your margin, the system immediately closes all your positions. The scariest part isn’t only that you lose your principal—sometimes you can also end up owing the broker a debt. This kind of situation is especially likely when you trade with leverage.

So why does liquidation happen? There are basically a few reasons. First is using too much leverage, which is the most common one. Imagine you use 100,000 as your principal and open a 10x leveraged position—effectively, you’re trading a 1,000,000 position. Then if the market moves against you by only 1%, your principal will lose 10%. If the move reaches 10%, your margin will be gone long before that. At the beginning, many people think they can control it, but the market is often much faster than they imagine.

Second is a stubborn mindset. Even though you’re already losing money, you refuse to let go and keep waiting for a rebound. Then you encounter a gap-down plunge, and the broker directly cuts your position at market price. Your losses end up far beyond what you expected. Third is failing to account for hidden costs. For example, if you day trade but don’t close the position and instead carry it overnight, the next day gaps down—and you get liquidated. Or if you play options as the seller and implied volatility suddenly spikes, the margin requirement can suddenly double.

There are also liquidity traps. If you trade illiquid instruments or trade during the night session, the bid-ask spread can become ridiculously large. You want to stop your loss at 100 yuan, but in the market there’s only a 90 yuan price with buyers—someone will take the other side. The worst scenario is a black swan event. For example, continuous limit-downs like the 2020 pandemic or the Russia-Ukraine war—sometimes even the broker can’t close positions. By the time the margin has been fully deducted to zero, you may still end up owing money.

Liquidation risk varies a lot across different assets. Crypto has the largest price swings. Even a 15% up-and-down fluctuation in Bitcoin can cause the majority of investors across the network to be liquidated. When Bitcoin is liquidated, it’s not only that the margin is gone—the coins you bought can also disappear. Forex margin trading is even more like playing with big money using small money. Many people like to enter by opening leverage, but once the market moves against them, liquidation comes extremely fast.

Stock trading is a bit more interesting. Buying spot stocks generally won’t lead to liquidation; at most, you’ll lose your principal. But margin buying is different. If the maintenance margin falls below 130%, you’ll receive a margin call, and if you don’t add funds, you’ll get forcibly closed (“duan tou”). A failed day trade that turns into an overnight position can also carry liquidation risk.

To avoid liquidation, the most important thing is to use risk management tools properly. Stop-loss and take-profit are absolutely crucial. Stop-loss means setting an automatic order-cutting price—when the price drops to that level, the system automatically sells for you. Take-profit means setting an automatic profit-taking price—when the price rises to your target, it automatically helps you lock in the gains. The key is to look at the risk-reward ratio—only when the profit is greater than the loss does it make sense.

When deciding the stop-loss and take-profit levels, experienced traders look at technical indicators such as support and resistance lines and moving averages. For beginners, using percentages is the simplest: set 5% above or below the entry price. That way you don’t have to stare at the chart all day—you stop out when it’s time to stop out, and you take profit when it’s time to take profit.

There’s also an important protection mechanism called negative balance protection. It means the most you can lose is the money in your account—you won’t end up owing the broker any debt. If you really end up at the bottom and losses run out, the platform will absorb the remaining mess. This is a very important protection for beginners.

In the end, liquidation is the cost of risk in leveraged trading. If you want to survive in the market long-term, rather than thinking about how to make big money, you should first learn how to stay in the market. Carefully assess your leverage multiplier, set stop-loss properly, and don’t be stubborn—once you’ve nailed these basics, the risk of liquidation can be greatly reduced. Investing has both gains and losses. Before doing any leveraged trade, you must understand risk management and make good use of stop-loss and take-profit tools to go even further.