Cryptocurrencies are notoriously volatile and every investor knows this. As a result, they are great targets for crypto liquidation.
The dreaded thing of cryptocurrency trading is liquidation, which happens when an investor is unable to pay the margin needed for their leveraged position.
Traders raise their trading capital by borrowing from a third party, in this case, an exchange.
While borrowing or leveraging cash to enhance trade positions might multiply possible earnings, it is a high-risk activity. If the market goes against your leveraged position, you may lose your initial margin or capital.
Crypto trading enables investors to aim high and shoot for the stars. It’s also not unusual in the volatile cryptocurrency market, where abrupt price fluctuations can fast lead to the involuntary termination of trades, also known as Liquidation.
Yet, with the appropriate approach and techniques, traders may avoid liquidation and maximize their profits.
What is crypto liquidation and how it happens
Liquidation is the method of trading crypto assets for fiat in order to limit losses, particularly in the event of a market meltdown.
In the crypto ecosystem, therefore, the term liquidation is mostly used to denote the forced closure of a trader’s position as a result of a partial or whole loss of the trader’s initial margin.
This occurs when they are unable to match the margin needed for their leveraged position, that is, they do not have enough funds to keep the transaction open. When the price of the underlying asset falls suddenly, margin needs are frequently unmet.
When this occurs, the exchange will close out the trade automatically, as such result in a loss of dollars for the investor.
The magnitude of this loss will be determined by the initial margin in place as well as the price drop. It can result in a total investment loss in some situations as some investors must have experienced
There are two types of liquidation: partial liquidation and total liquidation. As an example:
Partial liquidation: A liquidation that closes a position partially early on in order to lower a trader’s position and leverage.
Total liquidation: Ending a position when almost all of a trader’s initial margin has been utilized.
As investors, we know the volatile nature of cryptocurrency is well recognized and we have gotten the vibe. It implies that the market can turn against you at any time.
Furthermore, the crypto market has gotten even more volatile as the use of derivatives has increased. Margin trading, perpetual swaps, and futures are examples of derivatives.
All of them are contracts that enable traders to forecast where the price of a cryptocurrency asset will be in the future.
You take loans from the exchange when you trade with leverage. Assume you suffer a specific amount of loss in your position.
If the market moves against you, the exchange has the authority to close your trade. This serves as a security net to protect against further losses on leveraged bets.
How to avoid crypto liquidation
Stop loss: A stop order is indeed a type of order that can be placed on a cryptocurrency exchange to sell an asset when its price gets to a predetermined level. It is an excellent tool for risk management while trading with leverage.
When you place a stop order, you must indicate the stop price (or selling price) as well as the transaction size.
The exchange will automatically execute the order and sell the stated amount at the stated selling price when the asset’s price hits the stop price. Stop losses are a method for limiting your losses.
There is no hard and fast rule for establishing the stop loss point, however, it is generally recommended to keep it below 5% of the overall trade amount.
Always manage risk: Traders should constantly control risk by diversifying their portfolios and not investing more than they can tolerate losing.
Keep an eye on margin requirements: Traders should keep an eye on their margin requirements on a frequent basis to ensure that they have enough funds in their accounts to cover any potential losses.
Take good advantage of leverage: Traders who employ leverage should be cautious not to over-leverage their positions, as this increases the danger of liquidation.
Stay informed: Maintaining awareness of market news and happenings can assist traders to predict probable price moves and modifying their positions accordingly, taking advantage of every source of accurate information on the market will help.
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