The forced closing of a position when margin requirements are not met, potentially leading to losses.
Liquidation is the forced closing of a leveraged position when it no longer meets the required margin level. When price moves against a trader, the exchange automatically sells or closes the position to prevent further losses.
Liquidation protects exchanges and lenders from borrowers defaulting on leveraged positions.
How Liquidation Happens
A trader opens a leveraged position
The position moves into loss
Margin falls below the maintenance threshold
The exchange closes the position automatically
Remaining collateral (if any) is returned to the trader
The higher the leverage, the closer the liquidation price.
Factors Affecting Liquidation Price
Leverage level
Position size
Volatility of the asset
Exchange maintenance margin requirements
Funding rates and unrealized fees
High leverage dramatically increases liquidation risk.
Avoiding Liquidation
Use lower leverage
Add margin (“top up”)
Place stop-loss orders
Avoid trading during extreme volatility
Hedge positions with futures or options
Summary
Liquidation occurs when a leveraged position can no longer support its required margin. It is an automatic mechanism that closes the position to prevent further losses.
