What does liquidation mean? A mandatory liquidation risk that traders must understand [Margin Trading Guide]

In leveraged trading, sharp market fluctuations often cause significant shocks to investors. Many traders, due to a lack of understanding of the liquidation mechanism, ultimately face forced account liquidation. So, what does liquidation mean? How should this crucial concept for traders be understood?

What is liquidation? Core definition analysis

Liquidation refers to the situation where a trader’s account net worth falls below the minimum margin requirement set by the platform, resulting in the forced closing of positions by the exchange.

Simply put: when you trade with 100 yuan using 20x leverage, and the margin in your account is insufficient to maintain this leveraged position, the platform will automatically sell all your positions to protect itself. This process is called liquidation.

Core reasons for liquidation

Liquidation does not happen overnight but is the result of multiple factors acting together.

Market trend reversal is the most direct cause. If you go long on a certain coin and the price suddenly drops 15%, your account net worth will shrink significantly. For example, in virtual currencies, Bitcoin has experienced single-day drops of 15%, leading to large-scale liquidations across the market.

Excessive leverage is an implicit driver. A 5x leverage and a 50x leverage will lose 10 times more under the same price fluctuation. Many beginners are tempted by high leverage but do not realize that the risk multiplies accordingly.

Lack of margin buffer is also a common reason. If your margin ratio is maintained only at the platform’s minimum requirement (usually 30%), even small fluctuations can trigger forced liquidation.

Liquidation mechanisms for different asset types

Forex and CFD liquidation

In forex trading, liquidation is often called “forced closing.” Traders need to understand how margin is calculated:

100,000 × lot size ÷ leverage = required margin

Example: trading 0.1 lots of EUR/USD with 20x leverage requires a margin of = 100,000 × 0.1 ÷ 20 = 500 units.

When the available margin ratio in your account drops to the platform’s limit (usually 30%), forced liquidation will be triggered:

Margin ratio = Net worth ÷ Used margin × 100%

It is recommended for beginners to keep the margin ratio above 1000% initially, leaving ample risk buffer for the account.

Virtual currency liquidation carries the highest risk

The virtual currency market is highly volatile, and liquidation is triggered when client equity becomes negative. This means you not only lose all the margin in your account but may also owe money to the platform.

Historically, Bitcoin has experienced single-day 15% swings, causing large-scale market liquidations, with thousands of traders losing everything instantly.

Futures liquidation is relatively mild

Although futures also support leverage, compared to CFDs, trading flexibility is lower, and leverage multiples are usually smaller, so the likelihood of liquidation is significantly reduced. The trigger condition is also when equity turns negative.

Stock margin financing liquidation is rare

Normal stock trading almost never involves liquidation risk. It only occurs when using margin or short selling borrowed stocks. Usually, a margin of 90% of the stock’s value must be paid. When the stock you shorted rises, the broker has the right to request additional margin; if you cannot meet the requirement promptly, forced liquidation occurs.

What are the differences among liquidation, forced closing, and closing positions?

These three concepts are often confused; understanding their differences is important:

Closing position is a trader-initiated decision, closing the position based on stop-loss or take-profit prices, entirely under their control.

Forced closing occurs due to insufficient margin, where the platform forces you out, but losses are usually contained within a certain range.

Liquidation is the most extreme case. When the market gaps, the platform may not react in time, causing the account equity to become negative directly. Traders not only lose their margin but may also owe debts. It can be said that liquidation is an upgraded version of forced closing.

How to avoid liquidation through risk management

Use stop-loss and take-profit tools

Stop-loss (SL): When the price drops to your set level, the system automatically closes the position to limit losses. This is the first line of defense against liquidation.

Take-profit (TP): When the price rises to your target, the system automatically locks in profits.

By setting these two levels, you can calculate the risk-reward ratio:

Risk-reward ratio = (Entry price - Stop-loss price) ÷ (Take-profit price - Entry price)

A lower ratio indicates a better balance between potential reward and risk.

How to determine stop-loss and take-profit levels

Professional traders often refer to support and resistance levels, moving averages, and other technical indicators. If you’re still learning, you can use a simple percentage rule: set at ±5% of the entry price. This approach provides effective defense without being easily shaken out.

Negative balance protection mechanism

In regulated exchanges, negative balance protection is a necessary safety measure. This means you can only lose the amount deposited in your account; any excess is covered by the platform. This is especially important for novice traders, greatly reducing risk.

However, note that negative balance protection mainly safeguards small retail traders and may have limited applicability for professional traders.

Reasonable leverage control

Not all trades require maximum leverage. Beginners are advised to start with 3x or 5x leverage, gradually increasing as they gain experience. Remember: higher leverage increases the risk of liquidation.

Reserve sufficient margin buffer

Avoid letting your account margin ratio approach the platform’s minimum limit. Even if the platform requires a minimum of 30%, you should maintain 100% or more to leave room for fluctuations.

Insights from liquidation for traders

What does liquidation mean? Ultimately, it is the result of losing control over risk. It is usually not caused by a single reason but by the accumulation of multiple reckless actions: misjudging market direction, using excessive leverage, lacking stop-loss, or insufficient margin.

To survive in margin trading, the key is to have risk awareness at every step. Do not be tempted by high leverage and quick profits, nor rely on the market always being favorable. Use stop-loss and take-profit wisely, allocate margin reasonably, and adjust leverage dynamically. These are the long-term strategies for stable trading.

Investing involves gains and losses. Before trading, you must thoroughly learn trading knowledge and understand the risk attributes of each tool to go further in the market.