Veteran crypto traders are avoiding the "liquidation"; a must-know self-rescue guide for beginners

Once there is a sharp fluctuation in the market, many leveraged traders face a nightmare scenario—liquidation. The margin in their accounts evaporates instantly, and they may even owe money to the exchange. What exactly is going on? And how can it be avoided?

What does liquidation mean? Explained in one sentence

Liquidation refers to the situation where an investor, due to incorrect trading direction, sees their account equity (margin) fall below the minimum margin requirement, resulting in the platform forcibly closing their positions.

In simple terms, it means your margin is insufficient, and the platform, to cut losses, directly closes your positions. You have no choice in this process; it’s purely a passive response.

Why does liquidation happen? Different asset classes vary

Forex and CFD liquidation

Forex and Contracts for Difference (CFD) both use leverage to amplify gains, but also increase risks. Here’s a core concept called Prepayment Ratio:

Prepayment Ratio = Net Asset Value ÷ Prepayment × 100%

For example, if you trade with 20x leverage and buy 0.1 lots of a currency pair, the margin required is calculated as:

100,000 × 0.1 ÷ 20 = 500 (currency units)

As your floating losses in the account increase and net asset value decreases, the prepayment ratio also drops. Once it falls below the warning line set by the platform (usually 30%), the system will automatically trigger forced liquidation.

It’s recommended to keep the prepayment ratio above 1000% in the early stages to leave enough buffer for floating losses.

Cryptocurrency liquidation

The volatility in the crypto market is much higher than forex. Historically, there have been cases where Bitcoin’s single-day volatility of 15% caused mass liquidations across the network.

A special reminder here: When a cryptocurrency is liquidated, not only does the margin account’s funds get lost, but the platform also forcibly liquidates the held coins.

Futures and stock liquidation

Futures liquidation conditions are similar to cryptocurrencies—triggered when equity becomes negative—but since leverage multiples are relatively lower, the risk is slightly smaller.

Normal stock trading generally does not result in liquidation, only margin trading long or short carries this risk. If margin is insufficient, brokers have the right to forcibly close positions.

How to avoid the pitfalls of liquidation? Risk management tools are key

Take profit and stop loss: the most basic self-defense tools

Stop Loss (SL): Set a price limit; if the market falls below this level, the system automatically closes the position to lock in losses.

Take Profit (TP): Set a price ceiling; if the market rises above this level, the system automatically closes the position to lock in gains.

Using these two tools together allows you to plan your risk and reward ratio in advance:

Risk-Reward Ratio = (Entry Price - Stop Loss Price) ÷ (Take Profit Price - Entry Price)

A lower ratio indicates a more favorable risk-to-reward profile.

How to set the take profit and stop loss levels?

• Technical analysis: Refer to support/resistance levels, moving averages, and other indicators
• Percentage method: If technical analysis seems complex, simply set at ±5% of the entry price

Negative balance protection: a safety cushion for beginners

Regulated platforms typically offer this mechanism: When your account losses exceed your principal, the platform covers the excess, and you won’t owe money to the exchange.

This feature is especially friendly to newcomers, acting as a promise that you won’t lose more than your initial investment. However, note that this mainly protects beginners; high-leverage traders may not be fully covered.

What’s the difference between liquidation, forced closing, and normal closing?

Forced closing: When account equity hits the warning line, the platform automatically closes part of the position, usually to stop further losses.

Liquidation: During gap openings or fast market moves, the platform may not react in time, resulting in the margin being wiped out completely, possibly requiring you to deposit more funds.

Normal closing: Fully controlled by you, closing positions at your chosen take profit or stop loss levels or at your discretion.

In simple terms: Liquidation is an upgraded version of forced closing, with more severe consequences.

Final advice

Leverage trading is like wielding a double-edged sword; used properly, it can amplify gains, but misused, it can cut you deeply. Before engaging in any leveraged trading:

1. Fully learn trading knowledge and understand the risks of each product
2. Always set take profit and stop loss; don’t rely on luck
3. Keep the prepayment ratio at a safe level
4. Beginners should start with small positions, and increase leverage only after gaining experience

Remember: Protecting your principal always comes first; making money is second. Many accounts never recover after a single liquidation, and this is no exaggeration.