What Is Liquidation and How to Avoid It!
In investing, liquidation occurs when an investor/trader falls short of their margin requirement and their position gets liquidated by an exchange or custodian as per their risk management policies.
Let us first explore the difference between a partial liquidation and a total liquidation before we get too far into the details. A partial liquidation system is introduced in order to avoid large volumes of orders being placed on the market due to full Liquidations impacting the market negatively.
The term Full Liquidation is usually applied when a trader is incapable of meeting the margin requirements for a leveraged position, i.e. if he does not have sufficient funds to continue holding the position.
What is margin trading and how does it work?
The margin trade is a way for users to increase the amount of money they have at their disposal to trade by obtaining funds from a third party. This is the same as borrowing money or assets from a third party for buying/selling aka ‘SHORTING’.
Only the difference, in this case, is that you are borrowing from a cryptocurrency exchange such as the DIFX exchange. In this way, investors can increase the size of their trading positions in the market, which is what is known as leverage.
How does futures trading work and what is its purpose?
As a derivative contract, a futures agreement is a contract for the purchase or sale of a particular commodity asset or security. This is at a set price and date in the future. Contracts for futures, which are known as futures, are traded on futures exchanges. To trade futures contracts you need a brokerage account that’s approved for such trades.
Futures contracts that are perpetual can be held indefinitely without having to be rolled over as they approach expiration, which is a new and interesting feature that DIFX will be releasing in the next update. They tend to be cash-settled, and they differ from regular futures because there is no predefined expiration date.
This makes it quite clear that the futures market is an investment contract in which you invest in a derivative. In such a case, only a small upfront payment is required by the investor to initiate the contract. Therefore, the investor will not have to pay the full sum for the contract. Basically, it is an initial deposit on the total value that is required to start the contract. It is the exchange’s responsibility to set the margin and maintenance values.
Here are some tips on how to avoid liquidation:
It is pertinent to note that a stop-loss order will execute at a certain price, For investors, it is useful to know the price up to which they can bear a loss. In addition, it is helpful to know the size of that particular asset investor intends to liquidate.
In one example, the trader has $10,000 in his account and would like to create a $50,000 position. However, he wants to use an initial margin of $5,000 and leverage of 10x. At that point, he places a stop loss at 5% of the entry price. Compared to the entire amount of the trader’s account, a trader could potentially lose a mere $2,500 by participating in this particular trade. In the event that the trader does not use a stop loss, his position will be liquidated upon a 16% drop in the price of the asset which will result in $9,000 of loss.
Another trader uses a maximum of 100x leverage on a $10,000 trading account and an initial margin of $1,000 to make a position amounting to $100,000, although he only has $10,000 in his trading account. As long as the trader places his stop loss at a distance of 0.5% from his entry point, he stands to lose $500 in this position. This is a loss of 5% from his account.
In conclusion, this example is a very illustrative example of how, even though using higher leverage is usually very risky, it becomes very significant if your position size is large, as seen in the second example. You should maintain a loss per trade of less than 5% of your entire account size so that you are able to avoid any unnecessary losses. Using leverage or borrowing funds to increase your trading positions can lead to a greater return on your investment, but is a highly risky move, and can equally magnify your losses. Despite this, you can avoid liquidation by keeping an eye on your margin, leveraging in a reasonable manner, and using trading tools such as stop-loss and limit orders.
DIFX shall not be responsible for any loss arising from any investment based on any recommendation, forecast or other information herein contained. The contents of this publication should not be construed as an express or implied promise, guarantee, or implication by DIFX that the forecast information will eventuate, that clients will profit from the strategies herein or that losses in connection therewith can or will be limited. Trades in accordance with the recommendations in an analysis, especially leveraged investments such as foreign exchange trading and investment in derivatives, can be very speculative and may result in losses in particular if the conditions or assumptions used for the forecast or mentioned in the analysis do not eventuate as anticipated and the forecast is not realized.
DIFX is a CEX that uses blockchain technology to incorporate centralized finance. It is an easy-to-use platform for both new and experienced traders, establishments, and investors. As covered by Cointelegraph, BeInCrypto, and many other media outlets, DIFX allows users to nominate anyone from their family, friends, or loved ones and allows them to legitimize their claim upon the primary user’s demise.
Additionally, the company hopes to increase the use of digital currencies for direct settlement between beneficiary and payer by eliminating intermediaries. To begin your journey with Endless Possibilities, download the app now from the iOS or Google Play Store, or visit us at difx.com.