What does liquidation mean? Why does liquidation occur in investment trading? An in-depth analysis of risks and prevention strategies

A market turning point can cause your principal to evaporate in an instant; a misstep with leverage can lead to losses that leave you in debt—this is the phenomenon investors fear most: “Liquidation”. It not only wipes out all your funds but can also trap you in debt. So how exactly does liquidation occur? Why is high leverage so risky? And what measures can be taken to prevent catastrophic losses? This article will comprehensively analyze the causes of liquidation and strategies to cope, helping you safeguard your investment capital.

In-Depth Understanding of Liquidation: Concepts and Causes

Definition of Liquidation

“What does liquidation mean” — Simply put, it occurs when a trading position is wrongly judged, and losses exceed the margin amount, prompting the trading system to forcibly close the position. Specifically, when your account net worth falls below the minimum maintenance margin set by the broker, the system will mercilessly liquidate all your positions at once, cutting off your chance to recover. This process is called “liquidation”.

Conditions Necessary for Liquidation

• Trading direction opposes the actual market trend
• Losses rapidly increase, depleting available margin
• Account equity falls below the broker’s maintenance margin requirement
• Automatic liquidation mechanism is triggered

Five Common Dangerous Operations Leading to Liquidation

1. Excessive Leverage

Leverage is like a double-edged sword; it amplifies gains but also risks. Many investors underestimate this. For example, using 100,000 yuan of capital with 10x leverage to trade options effectively controls 1 million yuan. Under this setup, if the market moves against you by 1%, your principal loses 10%; if it moves 10% against, your margin is completely consumed, leading to margin calls and forced liquidation.

Historically, many investors have been wiped out in single market swings due to over-leverage.

2. Holding on to Losing Positions in Hope of Rebound

“Just wait a bit, it will bounce back”—this mindset is one of the deadliest traps in trading decisions. Markets often gap down unexpectedly when you’re least prepared, and brokers may liquidate positions at market price at the open, resulting in losses far exceeding expectations. Refusing to cut losses can turn manageable losses into uncontrollable ones.

3. Overlooking Hidden Costs

Many retail traders overlook traps such as:

• When day trades fail to convert into overnight positions, margin requirements suddenly increase the next day
• Selling options during volatility spikes (e.g., major political or economic events), doubling margin requirements
• Hidden fees and financing interest accumulating over time

4. Price Gaps Due to Low Liquidity

In less popular assets or during after-hours trading, bid-ask spreads can be extremely wide. Your stop-loss order might execute at a price far below your intended level—for example, planning to stop at 100 yuan but executing at 90 yuan—accelerating liquidation.

5. Black Swan Events Causing Extreme Risks

Major events like the COVID-19 pandemic, Russia-Ukraine war, etc., have caused consecutive limit-downs. In extreme cases, even brokers cannot close positions, and investors face losses exceeding their margin, risking margin calls and account wipeouts.

Risk Comparison Across Different Asset Types

The risk of liquidation varies depending on the asset class. Understanding each asset’s characteristics is key to making appropriate investment decisions.

Cryptocurrency: High Volatility, High Risk Zone

Cryptocurrencies are known for their large price swings, making them high-risk for liquidation. There have been cases where Bitcoin fluctuated by 15% in a day, causing most holders to be liquidated. During crypto liquidation, not only does the margin evaporate, but the entire position is automatically sold off, and assets vanish completely.

Forex Trading: Classic Leverage Scenario

Forex margin trading is essentially a leverage game that uses small capital to control large positions. Many investors are attracted by low margin requirements but overlook the risks involved.

Key Concepts in Forex Trading:

Contract sizes are divided into three types:

• Standard lot (1 lot): largest size
• Mini lot (0.1 lot): medium size
• Micro lot (0.01 lot): suitable for beginners

Margin Calculation Logic: Margin requirement = (contract size × lot size) ÷ leverage

For example, trading 0.1 lot of currency pair (assuming a face value of $10,000) with 20x leverage: Required margin = $10,000 ÷ 20 = $500

When your account balance drops to the platform’s minimum ratio (usually 30%), forced liquidation is triggered. If only $50 remains in your account and losses reach $450, the system will automatically close your position—that’s when liquidation occurs.

Stock Market: Huge Differences in Trading Methods

Safety of Spot Trading

Using 100% of your own funds to buy stocks is the safest approach. Even if the stock price drops to zero, you only lose your principal, with no debts or margin calls.

Risks of Margin and Day Trading

Margin buying means borrowing from the broker; if the maintenance ratio falls below 130%, you receive a margin call. For example, using 600,000 yuan of margin to buy stocks worth 1 million yuan, a 20% drop in stock price can trigger a margin call.

Failing to close positions within the same day (day trading) and holding overnight positions increases risk significantly. If the stock gaps down at the open and no one takes over the position, the broker will liquidate, and insufficient margin leads to liquidation.

Core Strategies to Prevent Liquidation

Conservative Path for Beginner Investors

1. Start with spot trading: buy stocks with idle funds, avoiding the risk of being forcibly sold out
2. Avoid high-leverage products: futures, contracts, and other leveraged instruments are better left to experienced investors
3. Use dollar-cost averaging: compared to all-in one shot, DCA reduces risk by at least a hundredfold

Advanced Risk Control for Those Wanting Leverage

1. Start with micro contracts: use 0.01 lot to familiarize yourself with market logic
2. Limit leverage: initially, do not exceed 10x
3. Always set stop-loss orders: never gamble directly against the market

Practical Use of Risk Management Tools

Risk management tools are lifesavers in trading, helping you cut losses in critical moments.

Importance of Stop-Loss and Take-Profit

Stop-Loss (SL): set an automatic exit price; when the price falls to this level, the system closes the position to prevent further losses.

Take-Profit (TP): set an automatic profit target; when the price reaches this level, close the position to lock in gains.

These two functions are the first line of defense against liquidation.

( Calculating Risk-Reward Ratio

The risk-reward ratio reflects “how much risk is taken to gain how much reward.” The lower the ratio, the more attractive the trade. For example, risking 1 yuan to gain 3 yuan yields a 1:3 ratio, which is relatively safe.

Calculation formula: Risk-Reward Ratio = ()Entry Price - Stop-Loss Price() ÷ ()Take-Profit Price - Entry Price###)

( How to Set Reasonable Stop-Loss and Take-Profit Levels

Professional traders often use technical indicators (support/resistance lines, moving averages, etc.), but beginners can adopt the “percentage method”—setting 5% above and below the entry price as stop-loss and take-profit points. This way, no need to monitor the market constantly; stop-loss and take-profit are clear and straightforward.

) Negative Balance Protection Mechanism

In regulated trading environments, negative balance protection is a basic safeguard for investors. In short, you can lose at most all your funds in the account, and no additional debts will be pursued. Even if losses wipe out your bottom line, brokers will absorb the excess loss themselves. This safety net mainly protects novice investors, allowing room for mistakes.

However, some brokers proactively reduce leverage before major events to prevent extreme risk.

Final Risk Reminder

Investing involves both gains and losses. Before engaging in leveraged trading, thoroughly understand trading principles and reasonably assess your risk tolerance. Make full use of stop-loss and take-profit tools to safeguard your long-term investments, avoiding the tragedy of account wipeout.

Remember: controlling risk is always more important than chasing returns.