Crypto liquidation occurs when a trading position is forcibly closed by an exchange or trading platform to cover losses. This typically happens in leveraged trading, where traders borrow funds to increase their position size. Here’s a breakdown of how it works:
1. Leveraged Trading: Traders use borrowed funds to open larger positions than their actual capital allows. This can amplify both gains and losses.
2. Margin Requirements: Exchanges set margin requirements, which are the minimum amount of equity a trader must maintain in their account to keep a leveraged position open.
3. Triggering Liquidation: If the market moves against the trader’s position and their equity falls below the required margin level, the exchange will issue a margin call. If the trader cannot add more funds to meet the margin requirement, the exchange will automatically liquidate the position to prevent further losses.
4. Types of Liquidation:
- Voluntary Liquidation: The trader decides to close their position to minimize losses.
- Forced Liquidation: The exchange automatically closes the position when the margin requirement is not met.
4. Impact: Liquidation often results in selling the asset at less favorable prices, leading to potential losses for the trader.
Understanding these mechanics is crucial for managing risk in cryptocurrency trading.