Liquidation, also generally called liquidation, refers to the process by which the exchange forcibly closes trader positions. This occurs when a trader's losses on a leveraged position exceed the collateral or margin they posted when opening the position. At this time, the exchange will automatically sell the trader's assets to cover his position, which is the so-called forced liquidation or forced liquidation. This is also to protect the trader from further losses (I know you are confused, don't worry yet) , we will explain later).

Liquidation generally occurs in trading activities such as perpetual contract trading and margin trading.

Classification of liquidation

Specifically, liquidation can be divided into partial liquidation and full liquidation:

Partial liquidation generally occurs In the early stages before the initial margin is used up. As the name suggests, partial liquidation only liquidates a portion of a position to cover losses and maintain required margin levels. In this case, if the subsequent price movement of the crypto asset works in the trader’s favor, it may be possible to recoup their losses. However, this also exposes traders to greater risk if prices continue to move in an adverse direction.

Full liquidation is more straightforward, with the exchange forcibly closing the entire position to prevent any further losses. Although full liquidation protects traders from additional losses, it also causes traders to miss opportunities to recoup losses.

The positive meaning of liquidation

Now let’s explain why “forced liquidation can protect traders”.

In extreme market conditions, traders are likely to lose their entire margin within a short period of time. If the exchange does not forcefully liquidate the trader's account at this time, the trader will continue to "lose money" and the account amount will become negative, which is the so-called short position.

At this time, not only will the trader not be able to get back the margin, but he will owe the exchange a sum of money. The exchange will also worry that if the trader does not pay back the money, the loss will be irreparable. Although there are insurance and other measures to reduce such risks, this is undoubtedly something no one wants to see. Therefore, it can be said that forced liquidation "protects" the rights and interests of traders to a certain extent.

How is the liquidation price calculated

The calculation of the liquidation price needs to consider multiple factors, which mainly include: leverage multiple, entry price, position size and maintenance margin ratios. The following is the general formula for calculating the liquidation price for long and short positions in perpetual contracts:

Long position:Liquidation price = Entry price / (1 + (Initial Margin - Maintenance Margin) / Position size)

Short position:Liquidation price = Entry price / (1 - (Initial margin - Maintenance margin) / Position size)

Among them:

Entry price: The price when the trader opens a position

Initial margin: The place where the position is opened The required collateral percentage, usually calculated as (1 / leverage)

Maintenance Margin: The minimum collateral percentage required to keep a position open

Position size: The size of the position, usually expressed in units of the contract's base asset

It should be noted that the above formula is a simplified version. In actual operations, the exchange may use A more complex calculation as there are factors such as funding rates, fees and additional margin requirements to consider. Different exchanges may use slightly different formulas, so it's important to understand how your specific exchange calculates it.

Although the process of calculating the liquidation price is more cumbersome, the good news is that many times we don’t need to Manual calculation, most centralized exchanges will display your liquidation price and the probability of being liquidated at this time on your position interface. In addition, some exchanges will also provide liquidation price calculators, taking Binance as an example:

In Yong On the contract renewal interface, you only need to click on the calculator and select "Liquidation Price", then enter the leverage multiple, entry price and position quantity to calculate the corresponding liquidation price. The whole process is very convenient.

Liquidation mechanism and fees

Let us take the long position as an example to see how liquidation occurs. Assuming your initial margin is $100 and you establish 10x leverage on BTC, this means you borrow $900 and your total position is $1,000. If the price of BTC increases by 10%, you will make a profit of $100 from your trading position. If you don't use leverage, your profit is only $10, and leverage magnifies your profit.

If the price of BTC falls by 10%, your position would be worth $900. If the decline continues to increase, it will act on borrowed funds. To avoid losing the borrowed funds, the exchange will then liquidate your position to protect the funds lent to you. If you do not add margin before then, you will be forced to liquidate, which is the so-called liquidation, and you will also lose all the initial margin.

It is worth noting that forced liquidation usually also incurs additional liquidation fees, which is mainly to incentivize traders to manually close their positions before liquidation. So in reality, taking into account the issue of liquidation fees, it is very likely that your account will have been liquidated when the price of BTC only dropped by 9.5%.

In summary, traders must carefully manage risk when trading with leverage and maintain adequate margin levels to avoid liquidation.