In the world of trading, market volatility can sometimes wipe out your entire account balance in an instant—a terrifying event known as liquidation. This doesn't just mean losing your initial capital; it could also leave you in debt. How does liquidation occur? Why is high-leverage trading particularly dangerous? And what steps can you take to prevent such significant losses? This guide breaks it all down to help you protect your hard-earned money.
Understanding Liquidation: What It Is and Why It Happens
Liquidation occurs when your trade moves against you to the point that your account equity falls below the broker's required maintenance margin level. In simple terms, if the market moves opposite to your position and your capital (net equity) drops below the minimum threshold set by your brokerage, the system will automatically close all your positions. This is called liquidation.
Why does liquidation happen?
- Your trade direction is opposite to the market movement.
- Losses deplete your account to a level where it can no longer cover the required margin.
High-Risk Trading Behaviors That Often Lead to Liquidation
1. Excessive Leverage
Using high leverage is the most common cause of liquidation. Leverage acts as a double-edged sword: while it can amplify profits, it also magnifies risks. For example, if you use NT$100,000 to open a 10x leveraged position on Taiwan Index Futures, you are effectively controlling a NT$1 million position. In this scenario, a mere 1% adverse move would result in a 10% loss of your capital. If the market moves 10% against you, you could lose your entire margin deposit, face margin calls, and ultimately experience forced liquidation.
Many traders start with the belief that they can control risks, but market movements are often faster than anticipated. Always assess risks carefully and avoid letting leverage become a stumbling block in your trading journey.
2. Refusing to Cut Losses
This is a common mistake among retail traders. Holding onto a losing position with the hope that "it will bounce back soon" can lead to disaster—especially during a gap-down opening, where the broker liquidates your position at market price, resulting in losses far beyond expectations.
3. Overlooking Hidden Costs
Common pitfalls include:
- Failing to close a day trade, leading to additional margin requirements for overnight positions. A gap-down opening the next day can trigger liquidation.
- Selling options and experiencing a surge in volatility (e.g., during elections), which suddenly doubles margin requirements.
4. Liquidity Traps
Trading illiquid assets or during night sessions can lead to wide bid-ask spreads. Stop-loss orders might execute at unfavorable prices—for instance, intending to stop out at $100, but the order fills at $90 due to poor liquidity.
5. Black Swan Events
Events like the 2020 pandemic or the Russia-Ukraine war can cause consecutive limit-down moves, making it impossible even for brokers to close positions. This can wipe out your margin and potentially leave you with a negative balance, exposing you to over-loss risk.
Liquidation Risks Across Different Asset Classes
Not all investments carry the same risk of liquidation. New traders need not worry excessively; choosing the right assets and strategies can help you sleep soundly.
Cryptocurrency Liquidation
Due to high market volatility, cryptocurrencies are considered high-risk for liquidation. There have been instances where Bitcoin's 15% price swings caused mass liquidations across the market. It's important to note that when a crypto trade is liquidated, not only is your margin lost, but the coins you purchased may also vanish.
Forex Liquidation
Forex margin trading allows you to control large positions with a small amount of capital. Many traders in Taiwan use leverage to enter the market with less capital. Before discussing liquidation, beginners should understand the following:
Contract sizes come in three types:
- Standard lot: 1 lot
- Mini lot: 0.1 lots
- Micro lot: 0.01 lots (ideal for beginners)
How is margin calculated?
Margin = (Contract size × number of lots) ÷ Leverage
Example: Using 20x leverage to open a 0.1-lot position on Currency Pair A (assumed value: $10,000)
➤ Required margin = 10,000 ÷ 20 = $500
When your account's margin level falls below the platform's minimum threshold (usually 30%, but confirm with your broker), the broker will force-close your positions—commonly known as "liquidation."
Example: If you start with a $500 account balance and incur a $450 loss, leaving only $50, the system will automatically close your positions. This is liquidation.
Stock Market Liquidation
1. Cash Trading Does Not Lead to Liquidation
Buying stocks with 100% of your own funds (cash trading) is the safest approach. Even if the stock price falls to zero, you only lose your initial capital and won't owe the broker.
2. However, Margin Trading and Day Trading Can Lead to Liquidation!
- Margin trading (borrowing from the broker): If the maintenance margin ratio falls below 130%, you will receive a margin call. Failure to meet the call results in forced liquidation. For example, using NT$600,000 to margin-trade stocks worth NT$1 million means a 20% price drop could trigger a margin call.
- Failed day trade (unclosed position becomes overnight): If the stock gaps down limit-down the next day and cannot be sold, the broker will liquidate your position. If the margin is insufficient, liquidation occurs.
Recommendations for beginners:
1️⃣ Start with cash trading: Use disposable income to buy stocks; you won't wake up to a margin call.
2️⃣ Avoid leveraged products: Futures and contract trading are best left to experienced traders.
3️⃣ Adopt steady strategies: Dollar-cost averaging is far safer than going all-in.
If you still want to try contract trading:
1️⃣ Begin with micro lots: Trade 0.01 lots to familiarize yourself with the market.
2️⃣ Use low leverage: Newcomers should stick to 10x leverage or less.
3️⃣ Always set stop-losses: Never fight the market!
👉 Explore practical risk management tools
Using Risk Management Tools to Prevent Liquidation
Risk management tools act as a lifeline for traders, helping you control exit points and set stop-losses and take-profits. When the market turns suddenly, these tools prevent devastating losses. Here are some of the most useful features:
Stop-Loss and Take-Profit
A stop-loss (SL) is an order set at a predetermined price to automatically close your position if the market moves against you, preventing further losses. Conversely, a take-profit (TP) order closes your position when a target profit is reached, locking in gains. These functions are crucial for risk control, ensuring you don't lose everything in one trade.
The risk-reward ratio is a simple concept: potential profit should outweigh potential loss. A favorable ratio makes a trade worth taking—like risking $1 to make $3.
Risk-Reward Ratio = (Entry Price - Stop-Loss Price) / (Take-Profit Price - Entry Price)
How to Set Stop-Loss and Take-Profit Levels?
Experienced traders often use support/resistance levels or moving averages (MA) to set these orders. Beginners can use the straightforward percentage method—setting stops 5% above or below the entry price. This eliminates the need for constant monitoring and ensures disciplined trading.
Negative Balance Protection
Under regulatory oversight, negative balance protection is a mandatory mechanism for leveraged trading. It ensures that you can only lose the funds in your account without going into debt. If losses exceed your balance, the broker absorbs the remaining deficit. Some brokers may proactively reduce leverage before major events to mitigate risks. This protection is especially valuable for beginners, offering a safety net for learning.
Investing involves gains and losses. Traders should exercise caution in leveraged trading to avoid account liquidation. Before trading, acquire adequate knowledge and use risk management tools like stop-loss and take-profit orders for better long-term planning.
Frequently Asked Questions
What is the difference between liquidation and forced liquidation?
The core concept of liquidation and forced liquidation is similar, and many traders use the terms interchangeably. However, a subtle distinction exists: forced liquidation typically occurs when losses reach a specific ratio, varying by exchange rules. Liquidation, on the other hand, often refers to situations where gap movements cause prices to skip past stop levels, wiping out margin and potentially creating debt. Thus, liquidation can be seen as a type of forced liquidation, but not all forced liquidations involve debt. In practice, though, the terms are often used synonymously.
What is the difference between closing a position and liquidation?
Closing a position refers to voluntarily exiting a trade based on stop-loss or take-profit levels. Liquidation occurs when the broker forcibly closes your positions due to insufficient margin caused by adverse market movements.
Can you recover funds after liquidation?
Generally, once liquidation occurs, it is difficult to recover lost funds. This is why risk management and stop-loss orders are critical to protecting your capital.
Is liquidation possible in long-term investing?
Long-term investing in non-leveraged assets (like buying stocks with cash) does not lead to liquidation. However, if you use leverage or engage in margin trading, the risk remains.
How do brokers determine the liquidation price?
The liquidation price is calculated based on your entry price, leverage, and the broker's margin requirements. Most platforms display this price clearly, allowing you to monitor your risk.
What should I do immediately after a liquidation event?
First, avoid emotional trading. Review what went wrong, assess your risk management strategy, and consider practicing with a demo account before returning to live trading.
This content is for educational purposes only and should not be considered investment advice. Always consult independent financial advisors to understand the risks before making investment decisions. Leveraged products like CFDs carry a high risk of losing your entire investment and are not suitable for everyone. Trade with caution.