Recently, many beginner investors still have a somewhat unclear understanding of the concept of liquidation. So today, I’d like to explain what liquidation actually means and why this is so terrifying.

Simply put, liquidation happens when you bet on the wrong direction of the trade. You lose so much that even your margin isn’t enough to cover it, and then the trading platform directly cuts your position. The worst case isn’t just your principal evaporating—you may also end up owing the broker a large amount of debt. This isn’t scare tactics; it really can happen.

What does liquidation mean? It means that when your account equity falls below the minimum margin threshold required by the broker, the system will automatically force-close all your positions. You don’t get a chance to “turn it around,” and there’s no room to negotiate. The system just closes your positions.

Why does liquidation happen? The main reason is that the market movement goes against your trading direction, and your margin is not enough to absorb the loss. Especially when you use high leverage, even a small adverse move in the market can cause your principal to shrink dramatically.

High leverage is the most common culprit behind liquidation. I’ve seen many investment friends at the start think they can control risk—then once the leverage is turned up, the market only moves slightly in the opposite direction and they get liquidated immediately. For example, if you use principal of 100,000 and open a 10x leverage position to trade futures, that’s the same as trading a position size of 1,000,000. If the market moves 1% against you, you lose 10% of your principal; if it moves 10% against you, the entire margin is wiped out, and you may even face a margin call.

Another common pitfall is the “stubborn position mindset.” Thinking, “Just wait a bit longer—it will rebound,” but then you run into a gap-down crash. The broker then cuts your position at market price, and your losses end up far beyond what you expected. Some also ignore hidden costs, such as when a position that wasn’t closed out for day trading requires additional margin, and then the next day a gap opens and liquidation happens immediately; or when you trade a less popular instrument and encounter a liquidity trap, where your stop-loss order gets filled at an absurd price.

The most terrifying scenario is a black swan event. When events like the 2020 COVID-19 outbreak or the Russia-Ukraine war occur, with consecutive limit-down days, some brokers simply can’t close positions. When margin gets deducted completely and you end up in debt, you can end up with a cross-the-board default, i.e., your account can be wiped out.

Liquidation risk varies a lot across different assets. For cryptocurrencies, because market swings are large, they’re considered a high-risk zone. I remember Bitcoin has had up-and-down swings of 15%, which led to a large number of investors across the whole network getting liquidated. When crypto liquidation happens, it’s not just that your margin is gone—your bought coins can also disappear.

Forex margin trading is a game of playing big with small money. Many people like to open with leverage and enter using less margin. How is margin calculated? It’s very simple: margin equals (contract size multiplied by the number of lots) divided by the leverage multiple. For example, if you place an order with 20x leverage on 0.1 lot of a currency pair, with a value of $10,000, the required margin is $500. When your account’s prepayment ratio drops to the platform’s minimum setting (usually 30%), the broker will force-close your position.

Stock trading is a bit special. Buying spot stocks with 100% of your own funds is the safest. Even if the stock price drops to zero, you only lose your principal—you won’t owe any debt. But buying stocks with margin is different. If the maintenance margin ratio falls below 130%, you’ll receive a margin call. If you don’t add money, you’ll get cut off. Also, failed day trading that turns into a carryover position is dangerous. If the next day gaps down and hits the limit, you can’t sell, and the broker will cut your position.

To avoid liquidation, first use risk management tools like stop-loss and take-profit. A stop-loss sets an automatic order price; when the stock price falls to that level, the system automatically sells to prevent losses from getting worse. Take-profit sets an automatic profit-taking price; once the price rises to your target, it automatically locks in gains. These two functions are extremely important—they help you control risk.

Beginners can use a simple percentage method: set 5% above and below the entry price, and you won’t have to worry and watch the market all day. Experienced traders decide where to set stop-loss and take-profit levels by looking at technical indicators like support and resistance lines and moving averages.

Also, be sure to pay attention to the negative balance protection mechanism. On regulated exchanges, this protection ensures that at most you can lose only the money in your account—you won’t owe a large debt. If your losses really hit the bottom, the exchange will absorb the remaining mess itself.

Advice for beginners is simple: start by practicing with spot trading. Using spare money to buy stocks won’t have you wake up to a sudden margin call and be cut off. Avoid leveraged products—like futures contracts—until you’re experienced. Keep your strategy steady, and doing fixed-interval investing is 100 times safer than going All-in.

If you still want to play contract trading, start by practicing with micro lots, don’t open leverage to the max, and for beginners the recommendation is below 10x. Most importantly, always set a stop-loss. Never go against the market by force. Investing involves both gains and losses. Before making any trades, you should properly understand trading knowledge, make good use of risk management tools to set stop-loss and take-profit ranges, and only then can you avoid the tragedy of your account going to zero.