What Is Liquidation?

Liquidation occurs when the exchange is forced to close a trader’s position. This happens when the mark price – a reference price of a derivative calculated as a weighted index price meant to be fair and manipulation-resistant – reaches the liquidation price. 

Liquidation Price and Bankruptcy Price: What’s the Difference?

The liquidation price is the price that triggers liquidation, which happens when your margin is not sufficient to maintain your open positions. The liquidation price precedes the bankruptcy price.

When the liquidation price is reached, the exchange then begins automatically closing a trader’s position because the margin can no longer support it. Next comes the bankruptcy price, which is the exact amount of the collateral that the trader has deposited. It means when the bankruptcy price is reached (where the margin price is zero), the trader will lose their collateral and their position eventually incurs an auto deleveraging (ADL). 

How to Avoid Liquidation 

Since the liquidation price is reached if the margin is not enough to support your position, the most important thing is to maintain your margin and avoid large losses. 

Many traders think that the easiest way to avoid liquidation is to increase the margin, but it is never a good idea to add margin to a loss. 

For this reason, it is fundamental to do your own research before investing in futures contracts, to try to avoid unsuccessful positions. After careful consideration, you can then put in place strategies to avoid the liquidation price: 

• If you have more than one position open, try to close losing positions to save your margin; 
• Remember that higher leverage will reduce your margin, so consider adjusting leverage according to your projected results after careful analysis. This is another good option to avoid liquidation; 
• A good stop loss will allow you to avoid extensive losses, so it prevents you from decreasing your margin. 

Conclusions

The liquidation price involves a forced close of your positions before reaching an ADL event. Of course, liquidation entails a loss, something all traders and investors want to avoid. For this reason, it is always important to consider your margin carefully when opening a position, as trading crypto futures contracts offers advantages as well as high risk due to market volatility.