The popularity and expansion of cryptocurrencies has piqued the interest of many individuals in cryptocurrency trading. People’s interest has also grown due to the potential for higher returns with a leveraged account. However, if you fail to manage a deal properly, you may be forced into liquidation and lose everything. How can you prevent liquidation in crypto, and what is it?
What Does Crypto Liquidation Mean?
Liquidation, in general, is the process of converting an asset into cash. But it has a somewhat different connotation in the realm of cryptocurrency trading. When the value of a cryptocurrency falls, an exchange may cancel a trader’s leveraged position automatically. This occurs when a trader does not have enough money to start a leveraged deal. In other words, one of the hazards of margin trading is that they cannot make the margin call.
You could lose all of your collateral (known as “initial margin”), and your position might become liquidated if the market significantly swings against your leveraged position. In other words, you will relinquish your original capital contribution to the exchange.
What is Crypto Margin Trading?
Margin trading for cryptocurrencies is taking out loans from cryptocurrency exchanges to improve trading volume. Leverage also refers to this. Leverage allows you to establish a bigger position with less cash, which raises your potential profit. However, it poses a greater danger. The danger of liquidation will grow if the market is unfavorable to you.
Exchanges often need you to provide an initial margin in the form of fiat money or crypto assets as collateral if you wish to create a margin trading position. It seeks to balance the risk the lender assumes in the event of a trading loss.
How Does Crypto Liquidation Happen?
A leverage ratio of 10x would allow you to purchase a cryptocurrency asset worth $10,000 for just $1,000. If the price rises by 5%, you will make a $500 profit or a 50% return. You will lose $500, which is 50% of the asset’s value if it declines by 5%. The exchange will immediately liquidate the trade and end the position if the price drops by 10%, or $1,000.
You will get a margin call before the liquidation, requesting further margin. You must keep putting up a margin to maintain the position if the price continues to fall. The job will be closed if that happens. If you establish a trade with a 20x leverage, liquidation will occur with only a 5% price decline.
Conclusion
Before engaging in crypto trading, you should be familiar with liquidation and how to avoid it. A trader’s cryptocurrency investment must be liquidated if the margin requirements for their leveraged position cannot be satisfied. By borrowing money from an exchange, traders may trade with more money.
While using leverage or borrowing money to expand trading positions might raise prospective profits, it’s a dangerous activity that can also increase your losses. However, you may prevent liquidation by monitoring your margin, utilizing prudent leverage, and using trading tools like stop-loss and limit orders.
