In trading, “liquidation” refers to the events when the trader is forced to close their open position due to insufficient margin or collateral to cover the losses and costs to maintain the position.

Such events lead to significant losses and they usually occur for the following reasons:

  • Market volatility: by nature, certain assets are more speculative than others and the dynamic of the price movements of such assets may be fueled by low liquidity, unexpected news or a flurry of other factors. This oftentimes leads to margin calls, requiring traders to either add more funds or to close the position entirely before being liquidated.

  • Position margin: the collateral that is used between the parties to enter into the contract and is also used to pay out the market fees and maintenance costs, deducted from the contract collateral. This in terms increases the risks and likelihood of the liquidation in the long run, and should therefore be maintained properly.

  • Leverage: allows the traders to access more capital and amplify the profits. The danger is that your collateral can be drained much faster as well (as the fees charged on the position are charged not for the collateral value, but rather the position value which is amplified with the proportional leverage) if the market moves against the positions of the trader.

To minimise the risks of liquidations (and relveant fees, along with the loss of capital incurred with such events), it is a common practice to:

  • Set appropriate SL orders, and measure the risk/reward ratio carefully.

  • Maintain a sufficient margin balance to maintain the necessary collateral to meet the margin requirements.

  • Set lower leverage: While higher leverage yields better payoffs, it also exposes you to higher losses even at minimal moves.

  • Analyse the market conditions. It’s very important to keep track of all industry news that revolve around the particular assets you are trading with, since some of the news or events may help you make a better informed decision.

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