What is Liquidation in Cryptocurrencies and How to Avoid it?
The topic “Liquidation in Cryptocurrencies” begins with the debate on Future positions and Margin trading.
In the futures market, You are purchasing or selling contracts that represent the value of a certain cryptocurrency. You do not own the underlying cryptocurrency when you buy a futures contract. Instead, you own a contract with an agreement to buy or sell a specific cryptocurrency at a future date. As a result, owning a futures contract does not qualify you for any economic benefits such as voting or staking.
With futures contracts, you can take advantage of price volatility and profit from price movements. Whether prices increase or decrease, futures contracts allow you to easily participate in the fluctuations of a cryptocurrency. In other words, rather than purchasing the underlying item, you might speculate on its price.
Margin trading is borrowing third-party funds to increase the amount of money you have to trade with. Consider it borrowing money from a stranger in order to purchase bitcoin or another cryptocurrency. However, in this scenario, you are borrowing from a cryptocurrency exchange. This enables investors to enhance the size of their trading positions, which is referred to as “leverage.”
What is liquidation?
In finance and economics, liquidation is the process of closing a firm and allocating its assets to claimants. It is an event that often occurs when a firm is insolvent, which means it is unable to fulfill its debts when they become due. As the company’s activities come to an end, the residual assets are utilized to pay creditors and shareholders in the order of their claims. General partners are subject to liquidation.
What is Liquidation in Cryptocurrencies?
When an exchange forcibly closes a trader’s leveraged position due to a partial or whole loss of the trader’s initial margin, this is referred to as liquidation in the context of cryptocurrency markets. When a trader is unable to fulfill the margin requirements for a leveraged position, this occurs (fails to have sufficient funds to keep the trade open.) The concept of liquidation applies to both futures and margin trading.
When trading with leverage, the liquidation price is something you should pay serious attention to. The higher the leverage you use, the closer the liquidation price is to your entry.
In most cases, forced liquidation includes an additional liquidation fee. This varies with every platform, but it exists to encourage traders to close their positions manually before they are automatically liquidated. So, before you take a leveraged position, be sure you’re well aware of all these risks.
Trading with a leveraged position is a high-risk strategy, and you could lose all of your initial margin (collateral) if the market moves against your leveraged position.
Why Most Traders Fail – Reasons
- Over-Leveraging and Risky Positions
- Poor Risk Management
- Lack of Trading Knowledge
1. Over-Leveraging and Risky Positions
Over-leveraging is frequently the result of a trader’s overconfidence in the trade’s outcome. It’s like hitting a home run every time you take a swing. The issue with this strategy is that it is completely unsustainable.
2. Poor Risk Management
Poor risk management isn’t protecting funds with stop-loss orders, not calculating liquidation prices, putting total funds in on account, etc.
When you’re first starting out, every penny counts. As a result, in order to secure your money, you should follow stringent money management guidelines of that exchange platform.
3. Lack of Trading Knowledge
If someone starts trading without any knowledge of crypto trading, then, there are high chances of liquidation in the future and margin trading. Undisciplined and irresponsible practices are a prevalent cycle that novice traders fall into, causing them to fail.
Most beginners and emotional traders don’t know how to analyze market conditions, how to read graphs, what are the risks, what is isolated and cross margin, and when should I invest. This lack of trading knowledge can cause liquidation.
Tips to from Getting Liquidated in Crypto
Now, we are going to share some most effective and working tips to avoid liquidation chances. If you follow these tips, you can securely benefit from cryptos in long term.
Use the stop-loss Function
Stop-loss is a trading tool that automatically decides to sell assets when the market price hits a certain level, restricting the maximum loss of a trade.
The simplest and most successful strategy to avoid liquidation is to put a stop-loss order (specify the appropriate level of liquidation to minimize losses), which allows you to close the trade in advance at a small loss if something goes wrong.
Understand Cross and Isolated Mode
- An isolated account is a balance allocated to an individual position in future or margin trading. The isolated Margin mode allows traders to manage their risk on separate positions by limiting the amount of margin available for each. Each position’s allotted margin balance can be adjusted individually.
- While on the other hand, “In Cross Margin mode, the entire margin balance is shared across all open positions to avoid liquidation. If Cross Margin is enabled, the trader risks losing their entire margin balance along with any open positions in the event of a liquidation.” If Cross Margin is enabled, the trader risks losing their entire margin balance along with any open positions in the event of a liquidation.
The isolated margin position is not dependent on the amount of your other isolated funds in your account or your borrowing behavior. When a trader’s position is liquidated in Isolated Margin mode, just the Isolated Margin balance is liquidated, not the whole margin balance.
The Isolated Margin amount can be adjusted for open positions. If a position in Isolated Margin mode is close to being liquidated, liquidation can be prevented by allocating additional margin to the position.
For open positions, the Isolated Margin amount can be adjusted. If a position in Isolated Margin mode is in danger of being liquidated, an additional margin can be allocated to the position to prevent liquidation.
It all depends on your risk management strategy and how you manage your isolated or cross mode, according to your positions.
Don’t use your whole Capital
It is important to understand that a trader does not have to use all his capital as collateral to open a margin position. It is a top recommendation that traders shouldn’t put whole capital for future or margin trades.
In case of market moves down, you will not have any option to secure your positions by investing more funds. So, a spot-holding balance can save you from liquidation in case of a market dump.
Calculate your Liquidation Price
Before you start a position, many trading platforms will let you calculate your liquidation price. Binance Futures offers a helpful calculator that allows you to figure out your PnL (Profit and Loss), target price, and liquidation price ahead of time.
So, Calculate your Liquidation Price before opening a position.
Use lower leverage
When you use higher leverage, you’re looking for a chance to make even more money. It is, however, detrimental in the case of losses. Therefore, keep safe by using lower leverage. It can save you from liquidation. It is suggested to take a low risk and use lower leverage.
Keep a Higher balance in Futures
In case of a price drop, please ensure that you have enough margin balance in your futures account. The higher the margin balance and low the risks can decrease the liquidation chances.
Monitor the Margin Ratio
To avoid liquidation, Cross Margin or “Spread Margin” can use the client’s whole balance (Maintenance Margin). That is, the profit from one transaction will immediately offset the loss from another trade that was opened at the same time. This form of leverage is appropriate for traders who are executing many trades on different trading pairs at the same time or who are engaged in arbitrage — that is, when they are attempting to profit from the differences in exchange rates between different exchanges.