Full Analysis of Liquidation: How to Identify and Avoid the Crisis of "Forced Exit" in Trading Markets

In trading markets, the most feared term for investors is probably “爆倉” (liquidation). It means your account is wiped out instantly, or even owes debts. Many people think liquidation only happens in futures markets, but they don’t realize that cryptocurrencies, forex, and margin stocks can all trigger this trap. How exactly does liquidation occur? Which trading habits are most likely to hit the landmine? This article will help you understand the ultimate risk in trading markets.

What exactly is liquidation? Why does forced closing happen

Liquidation simply means that when your account net worth falls below the minimum margin threshold set by the trading platform, the system automatically forces all your positions to close. In other words, if the market moves against your position and your losses deplete your margin to the point where you cannot cover the required collateral, the platform will automatically cut your positions, leaving no chance to recover.

The core reasons leading to liquidation are twofold:

First, trading in the exact opposite direction — expecting the market to rise but it falls, or holding a short position during a surge. Second, insufficient margin — losses have already consumed all your funds, causing your account equity to fall below the maintenance margin requirement. When both conditions occur simultaneously, liquidation is imminent.

The five high-risk operations that bring you closer to liquidation

1. Setting leverage too high — seeming to earn quickly, but actually dying faster

High leverage is like a double-edged sword; it can amplify profits but also magnify losses. For example: using 100,000 USD of capital with 10x leverage on futures contracts is equivalent to controlling a 1 million USD position. If the market moves only 1%, your principal loses 10%; if it moves 10% against you, your entire capital is wiped out, and you face margin calls, ultimately leading to forced liquidation.

Many beginners start confidently believing they can control risks, but market volatility often exceeds expectations. It is recommended that beginners keep leverage below 5x, accumulating experience while adjusting leverage accordingly.

2. Overtrading mentality — the deadly illusion of “just wait a bit for a rebound”

Retail traders often make the mistake of holding onto losing positions with hope, expecting a miraculous rebound. But when the market gaps down sharply or brokers liquidate positions at market price at open, your losses can far exceed your expectations. At that point, it’s too late to regret.

3. Hidden costs not fully calculated — day trading with open positions, options selling as traps

Many forget that if you don’t close a day trade, it automatically becomes a position held overnight, requiring additional margin the next day. If the market gaps open, it can cause a sudden explosion in margin requirements. Or, after selling options, if volatility surges (like during elections), margin requirements can double instantly, putting your account under severe stress.

4. Liquidity traps — illiquid assets and night trading spreads are killers

Trading illiquid assets or operating during low liquidity hours can lead to large bid-ask spreads. If you want to set a stop-loss at 100, but the market only quotes 90, your execution price may be much worse than expected, causing losses to spike rapidly.

5. Black swan events — unexpected market crashes ruin all plans

Events like the COVID-19 pandemic or the Russia-Ukraine war led to continuous limit-downs, showing that sometimes the market drops so sharply that brokers cannot close positions in time. In such cases, margin can be completely exhausted, and investors face “穿倉” (underwater accounts) — owing debts to brokers.

How big is the difference in liquidation risk across different assets

Cryptocurrency liquidation — high volatility, highest risk level

The amplitude of crypto markets far exceeds traditional financial assets. For example, Bitcoin once fluctuated 15% within a single day, causing collective liquidations across the network. The terrifying part of crypto liquidation is that not only can your margin be wiped out, but your purchased virtual assets can also be forcibly liquidated and converted to cash by the platform, leaving your account at zero instantly.

Forex margin trading — playing with small money for big money

The forex market allows traders to leverage large positions with minimal margin. Many traders like high leverage because it requires less capital to enter. But the key is to understand the contract rules:

There are three contract specifications:

• Standard lot (1.0 lot): full unit of the standard currency pair
• Mini lot (0.1 lot): one-tenth of a standard lot
• Micro lot (0.01 lot): best for beginners to practice

Margin calculation: Margin = (Contract size × Number of lots) ÷ Leverage

Example: Using 20x leverage to trade 0.1 lot of a currency pair (assuming $10,000 value) Required margin = 10,000 ÷ 20 = $500

When your account equity drops to the platform’s minimum threshold (usually 30%), the system automatically closes the position, known as “断头” (liquidation). For example, if your account balance is $500 but your losses reach $450, leaving only $50, you cannot maintain the position, and the system will close it immediately.

Stock margin trading and day trading — not all stock operations will lead to liquidation

Buying stocks outright is the safest — only lose your principal, no debt

Using only your own funds to buy stocks means that even if the stock price drops to zero, you only lose your invested capital, and you won’t owe money to the broker. This is the most friendly option for beginners.

Margin buying can lead to liquidation — if maintenance ratio drops below 130%, you get a margin call

Margin trading involves borrowing money from brokers to buy stocks. When your maintenance ratio falls below 130%, the broker issues a margin call. If you don’t add funds, the broker will liquidate your positions. For example, using 600,000 USD of margin to buy 1 million USD worth of stocks, a 20% decline in stock price can trigger a margin call.

Failing to close day trades and leaving positions overnight can also lead to liquidation

Positions not successfully closed during the day become overnight holdings. If the stock gaps down limit-down and cannot be sold, brokers will liquidate the position. Insufficient margin results in liquidation.

How to use risk management tools to avoid the nightmare of liquidation

Stop-loss and take-profit — trading life-saving tools

Stop-loss (止損) is setting an automatic sell price to prevent losses from expanding. When the market hits that price, the system automatically sells. Take-profit (止盈) is setting a target profit price, at which the system automatically exits to lock in gains. These two functions are core to risk control.

Risk-reward ratio calculation: Risk-reward ratio = (Entry price - Stop-loss price) ÷ (Take-profit price - Entry price)

A lower ratio indicates a more favorable trade. For example, risking 1 dollar to make 3 dollars yields a 1:3 risk-reward ratio, which is considered worthwhile.

Practical methods for setting stop-loss and take-profit

Experienced traders often rely on technical indicators (support/resistance lines, moving averages) to determine stop-loss and take-profit levels. Beginners can use simple percentage methods — setting 5% above and below the entry price as stop-loss and take-profit points. This approach avoids over-monitoring and enforces discipline automatically.

Negative balance protection — the last line of defense

Regulated trading platforms must provide negative balance protection. Simply put, you can only lose all your funds; you won’t owe money to the platform. If liquidation causes your account to go negative, the platform absorbs the remaining loss. Some brokers proactively reduce leverage before major market moves to prevent huge losses. This protection is especially important for beginners, giving them room to learn from mistakes.

Three essential strategies for beginners to prevent liquidation

Strategy 1: Start with low leverage

Don’t open full leverage right away. Beginners are advised to start with 3x to 5x leverage, trading while gradually understanding market behavior.

Strategy 2: Prioritize assets with high liquidity

Major assets (like mainstream cryptocurrencies BTC, ETH, and major currency pairs) have sufficient liquidity, reducing the risk of liquidity traps. Illiquid assets often underestimate risks.

Strategy 3: Always set stop-loss, don’t stubbornly fight the market

Stop-loss is not admitting defeat but managing risk. Trading without stop-loss is like driving a car uphill without brakes — inevitably tragic.

Before engaging in any leveraged trading, investors should fully understand the trading mechanisms, market volatility, and make good use of risk management tools to set reasonable stop-loss and take-profit levels. Only then can they protect their principal in the long run. Remember: the premise of making money is surviving long enough.