How margin trading leads to the liquidation of your crypto position

Crypto traders using leverage are constantly at risk of having their positions suddenly closed. This phenomenon, known as liquidation, is one of the biggest threats in the margin trading world. To protect yourself as a trader, it is essential to understand exactly what drives this mechanism and what steps you can take to keep this risk under control.

Why does a trader choose leverage?

The appeal of leverage is understandable. By committing only a portion of your own capital as collateral (initial margin) and borrowing the remaining amount from the exchange, you can open much larger positions than normally allowed. This means that even small price changes can lead to significant profits.

Imagine you have €1,000 and use it with 10x leverage. You effectively open a position worth €10,000. If the price of your asset increases by just 5%, you make a profit of €500 – a 50% return on your initial capital. This kind of potential profit regularly attracts traders.

However, the downside of this strategy is equally significant. The same 5% price drop would mean losing €500 – 50% of your initial margin. And if the market drops further, you lose the borrowed money. This is when liquidation becomes imminent.

The liquidation process step by step

Let’s go through what happens when market conditions turn against you. Suppose you bought Bitcoin with 5x leverage. You deposited €2,000 as initial margin, and the borrowed amount is €8,000. Total position: worth €10,000 in Bitcoin.

Now, the Bitcoin price suddenly drops by 15%. Your position is now only worth €8,500. Your loss so far: €1,500. Your remaining margin is €500.

At this point, the exchange sends you a margin call – a message that you need to deposit more funds to meet margin requirements. You usually have some time to respond. You can add more funds or partially close your position.

But suppose you have no extra funds or refuse to act. The market continues to decline. When the price reaches your liquidation price – the level at which your remaining collateral no longer suffices – the exchange automatically closes your position. This happens without warning and without room for negotiation. Your entire position is sold, often with liquidation costs on top. These costs (usually 1-5% of the position value) go directly to the exchange.

What determines when liquidation occurs?

The liquidation price is not a random number. It is calculated based on several factors you need to understand:

Leverage factor: The higher your leverage, the closer your liquidation price is to your entry price. With 2x leverage, you have more buffer than with 10x leverage.

Maintenance margin: This is the minimum percentage of your position value that you must keep as collateral. Most exchanges require between 5% and 25%, depending on your leverage.

Asset volatility: More volatile assets generally require higher maintenance margins, bringing the liquidation price closer.

Your account balance: The more free funds you have on your account, the more buffer you have against sudden losses.

The two faces of liquidation

Not all liquidations are equal. There are two variants important to distinguish.

Partial liquidation

In some cases, the exchange does not close your entire position but only part of it. This usually happens when you respond quickly enough to a margin call and deposit additional margin. Your position is thus partially reduced to a level that again meets the requirements. This is generally a relatively favorable scenario – you lose money, but not everything.

Total liquidation

This is the worst case. Your entire trading holdings are sold by the exchange to cover all your losses. This always happens automatically and forcibly. Even worse: in extreme market situations, your losses can be so large that even after full liquidation, your account has a negative balance. The exchange will usually cover this via an insurance fund, but you will have not only lost your margin – you also owe money to the exchange.

Practical strategies to prevent liquidation

The good news is that preventing liquidation is largely in your own hands. Here are three proven methods.

Strategy 1: Set strict risk percentages

Professional traders follow a golden rule: never risk more than 1-3% of your total trading capital per transaction. Why? Because this means you go bankrupt only after 33 to 100 consecutive loss events – a scenario that practically never occurs.

Imagine: you have an account of €10,000. You decide to risk a maximum of 2% per trade, so €200. If you open a position with a 5% stop-loss, you are risking €4,000. Even if this trade goes against you, you only lose €200, not more. This creates a mental and financial buffer that protects you.

Strategy 2: Always use a stop-loss order

A stop-loss is your safety mechanism. You set in advance at which level you want to automatically exit. For example: you buy Ethereum and set a stop-loss 3% below your entry price. If the market crashes and passes this level, your position is closed automatically. Your loss is limited to 3%.

The beauty of stop-loss orders is that they remove emotions from the game. You don’t have time to panic and miss the right moment – the system does it for you.

Strategy 3: Be mindful with leverage

Leverage is like a knife – incredibly useful in the right hands, but dangerous if not respected. Many beginner traders make the mistake of always choosing the maximum available leverage. This is a strategy for disaster scenarios.

Instead, you should:

• Honestly assess your own risk tolerance
• Monitor current market volatility – use lower leverage during highly volatile periods
• Respect your trading strategy – if you hold long-term positions, do not use 10x leverage hoping for quick gains

Liquidation in the context of the volatile crypto market

It is crucial to realize that crypto is traded 24/7. This means liquidations can happen at any moment – even when you are sleeping. A geopolitical crisis on Sunday evening can lead to sudden price drops for which you have no time to react.

Therefore, preparation is everything. Your risk management must be so strict that even the most extreme market movements do not surprise you.

Frequently asked questions

Can liquidation happen in a few minutes?

Yes. With 5x leverage or higher, a sudden 15-20% price drop can liquidate you before you can act.

What happens if the exchange goes bankrupt?

Most major exchanges have insurance funds. These cover losses from liquidations. However, this is not a guarantee.

Is it possible to undo liquidation?

No. Liquidation is permanent. The position is closed and the exchange will not reopen it.

How many traders get liquidated per day?

In bull markets, this percentage is low (under 5%). In bear markets or volatile periods, it can be up to 20-30%.

Is margin trading suitable for beginners?

No. Margin trading with leverage is only for traders with extensive experience and strict risk protocols.

Conclusion

Liquidation is not a mysterious phenomenon but a direct consequence of inadequate risk management. By knowing your liquidation price, setting strict rules for risk percentages, always using stop-loss orders, and being cautious with leverage, you can fully protect yourself against forced liquidation. The most important thing is to realize that liquidation is not an accident – it results from decisions you have made. Make wise choices.