Forced Liquidation

What is Forced Liquidation?

Forced liquidation is nothing but a specific type of liquidation. Simply put, it is an involuntary action performed to preserve the leverage capital of the lender in a leveraged trade. Like the concept of liquidation, i.e., selling your assets for cash, your crypto assets are converted into stablecoins.

In the case of leveraged trades, the platform sets a designated value of liquidation (forced liquidation), which activates market orders to close the active leveraged positions. This easily explains to a trader that if the leveraged trade tends to continue losing funds, the lender has to take care of the loaned amount provided for the trader's position. It is then recovered with the intelligent mechanism of forced liquidation. This mechanism is similar for both futures and margin trading.

Understanding Leverage Trading and its Risks

For any leverage trader (futures or margin), liquidation price holds key importance as it is an automatic switch that will wash your capital away. With every increase in the value of leverage you wish to use, your liquidation price inches closer to your position's entry price. Here's an example to help you grasp the concept.

Imagine initiating your leverage trading career with $100 with your favorite King of Altcoin, Ethereum. Upon choosing the ETH/USDT pair, you will set the desired leverage amount, say 10x. This means that your position is worth $1000, not a mere $100. Do you understand the power of leverage? However, in the grand scheme, you only possess your original $100; the remaining $900 belongs to the lender.

Now imagine an increase of 50% in the price of Ethereum, the imagination's flashy, right? However, let's think the opposite for a while. The same amount of drop would mean that your position is now worth $500 from its starting value of $1000, and incurring further losses will only continue the decrement of your position size.

Why would a lender risk their funds being lost on your trading decisions? They won't. This is why they liquidate your position to protect their lent capital. Upon closure of the trade, the lender receives their original amount of $900, and you lose your capital amount of $100.

How to Minimize Your Risk?

Most trading platforms provide liquidity calculators before entering a position to instantly ensure you don't lose all of your trading capital. This allows you to easily calculate your Profit-n-Loss (PnL) before risking your capital.

While leveraged trade setups might sound extremely dangerous, they can be easily managed if you have a proper trading plan and are aware of how the market is performing.