In this article, you will learn what is liquidation and what does liquidation means? First of all, we explain what is liquidation means? After that, we will discuss how to avoid liquidation.
What is liquidation means?
The term “liquidation” is generally used to describe the process of converting assets into cash.
Leveraged positions are subject to unpredictable price movements, which can quickly send a trader’s equity into negative territory. Losses can be more than the maintenance margin in such instances, resulting in liquidation. If a deal has come to meet specified pricing conditions, this process is involuntary and automatic.
When does Liquidation Occur?
When a trader’s leveraged position’s margin requirements are no longer met, the position is forcibly liquidated.
Assume you have $100 in your account and want to open a long BTC/BUSD leveraged position. You entered a trade worth $2,000 with 20x leverage. Your account balance would be wiped out if the price of BTC dropped by just 5%, since you would no longer be able to meet the margin call demands to keep the trade afloat. In futures trading, this is referred to as liquidation.
Although this is a simple example, knowing your boundaries and how much you’re willing to lose on a trade is critical in determining how much leverage you should use.
To remain on the safe side, traders must have a plan with planned exits before entering any trade.
There are a variety of risk-avoidance strategies available, but you should consider the following to avoid liquidation.
1. Uses stop Lose
Using a stop loss is the most obvious way to avoid liquidation. A stop loss is a trading tool offered by the exchange that allows traders to establish a price at which a trade will automatically end if the price of an asset reaches this predefined threshold.
Using a stop loss and a liquidation calculator together can assist a trader’s account from substantial losses, particularly from liquidation.
The stop loss tool will protect you from losing all of your money on a trade and having to pay liquidation fees, even if you still lose some. After all, who wants to lose and be penalized? You can avoid this by employing a stop-loss strategy.
2. Decrease Leverage
Leverage has a big influence on how long a trade lasts. While using a lot of leverage can be appealing, it can also amplify your losses.
The high leverage can damage a trader even when a tiny price movement happens, as seen in the case above. As a result, lowering your leverage will help you navigate a turbulent crypto market more smoothly and safely.
3. Keep eyes on the Margin Ratio
Another alternative for traders is to keep an eye on the margin ratio. The trade will be liquidated when the margin ratio reaches 100%. Traders might add extra margin to their trade to restore leverage and lessen their position to avoid this scenario. When a trade is going in the wrong way, this strategy is similar to keeping a position alive.
Increasing margin or lowering leverage has the same effect as starting with less leverage in the first place. The difference is that maintaining a specified margin ratio is a dynamic solution that may be done over longer periods.
Liquidation is a frightening phrase that traders would rather avoid if feasible. The good news is that traders can use a variety of tools and trading tactics to prevent getting liquidated. Traders have various tools to avoid liquidation, including stop losses and margin ratio monitoring.