Liquidation risk in margin trading: Understanding the meaning of liquidation and self-rescue methods

Market volatility is unpredictable, and a single misjudgment can cause your investment account to be wiped out instantly—this is the liquidation risk all leveraged traders should be wary of. It not only consumes your principal but can also leave you in debt. How exactly does liquidation occur? Why is high leverage operation particularly dangerous? This article provides an in-depth analysis of the meaning of liquidation, helping you effectively avoid this investment trap.

Understanding the Meaning and Mechanism of Liquidation

Core Definition of Liquidation

Simply put, liquidation means: when your trading direction is misjudged and your losses accumulate beyond your account’s margin, the trading platform will automatically force close all your positions. At this point, you not only lose the chance to turn things around but your account equity will also fall below zero.

Why Does Liquidation Happen?

Liquidation usually occurs for two main reasons:

One is that the market trend is completely opposite to your prediction, causing your positions to continue losing. The second is that your account’s net worth drops below the broker’s minimum maintenance margin ratio, triggering a forced liquidation system. For example, if your maintenance margin requirement is 30%, once your account equity falls to this threshold, all your positions will be ruthlessly liquidated.

The Top Five Operational Traps Most Likely to Cause Liquidation

Over-Leverage Amplifies Risks

Leverage is like a double-edged sword; it can magnify profits but also exponentially increase losses. Suppose you use 100,000 yuan of principal with 10x leverage, controlling a 1 million yuan position. If the market moves just 1% against you, your principal will lose 10%; if it moves 10% against you, your margin could be wiped out entirely, and you may be required to pay additional margin. Many investors believe they can control risks, but market changes often exceed expectations, so be sure to carefully assess your leverage multiple.

Stubborn Mindset and Refusal to Cut Losses

A common mistake among retail investors is holding onto the hope “it will rebound soon,” but when faced with a gap down or a limit-down at open, the platform will directly liquidate at market price, resulting in losses far exceeding expectations. This stubborn mindset is a shortcut to liquidation.

Hidden Costs Ignored

If a day trade doesn’t succeed and you hold the position overnight, you will need to pay additional margin the next day. Or, if you sell options and volatility surges (such as during major political or economic events), margin requirements can double instantly. These hidden costs are often unexpected triggers for liquidation.

Liquidity Shortage Traps

In less popular assets or during after-hours trading, bid-ask spreads are often wide. If you set a stop-loss at 100 yuan but the only buyer is at 90 yuan, your stop-loss order will be executed at a much lower price than expected, causing additional losses.

Black Swan Events’ Sudden Impact

Major events like the COVID-19 pandemic or the Russia-Ukraine war caused continuous limit-downs, sometimes making it impossible for platforms to close positions, leading to margin calls and even owing money, facing the risk of being wiped out.

Risk Assessment of Liquidation Across Different Asset Classes

Cryptocurrency: High Volatility and High Risk of Liquidation

The crypto market is highly volatile; Bitcoin has experienced daily swings of up to 15%, causing many investors to be liquidated. The unique aspect of crypto liquidation is that not only is your margin fully lost, but your held coins may also be forcibly sold and disappear.

Forex Trading: The Double-Edged Sword of Leverage

Forex margin trading allows investors to control large positions with small capital, and many choose high leverage to reduce initial costs. But high leverage also means high risk.

In forex, there are three contract sizes to choose from: standard lot (1 lot), mini lot (0.1 lot), and micro lot (0.01 lot, most suitable for beginners).

Margin requirement formula: Margin = (Contract size × Number of lots) ÷ Leverage. For example, trading 0.1 lot of currency pair (worth $10,000) with 20x leverage requires a margin of $10,000 ÷ 20 = $500. When your account’s prepayment ratio drops to the platform’s minimum (usually 30%), the broker will execute a forced liquidation.

Stock Margin Trading: Risks of Margin and Day Trading Liquidation

Trading with actual funds (cash trading) means that even if the stock drops to zero, only your principal is lost, and no liquidation occurs. But margin buying is different—if the maintenance ratio falls below 130%, you will receive a margin call, and if you do not top up, your position will be liquidated. For example, using 600,000 yuan of margin to buy 1 million yuan worth of stocks, a roughly 20% decline in stock price will trigger a margin call.

Failed day trades (not closed out and left overnight) are even more dangerous. If the stock gaps down limit-down the next day and you cannot sell, the broker will forcibly liquidate your position, and insufficient margin can lead to liquidation.

Practical Advice for Beginners

For steady entry, it’s recommended to start with cash stock trading, using spare funds to avoid the risk of forced liquidation. Avoid futures, options, and other leveraged products until you have mastered the basics. A dollar-cost averaging strategy is safer than going all-in.

If you must trade derivatives, start with micro lots (0.01 lot), keep leverage below 10x, and always set stop-loss orders. Never confront the market head-on without protection.

Risk Management Tools: Traders’ Umbrella

The Importance of Stop-Loss and Take-Profit

Stop-loss (SL) sets an automatic sell price to prevent unlimited losses when the market falls to that level. Take-profit (TP) sets a target profit level to automatically lock in gains. Both are fundamental defenses against liquidation.

The risk-reward ratio is the proportion of risk taken to the expected profit. A lower ratio indicates a more favorable trade—risk 1 dollar to gain 3 dollars is far better than other ratios.

Calculation formula: Risk-Reward Ratio = ((Entry Price - Stop-Loss Price)) ÷ ((Take-Profit Price - Entry Price))

How to Set Stop-Loss and Take-Profit Levels

Experienced traders often refer to support and resistance levels, moving averages, and other technical indicators. Beginners can use a simpler “percentage method,” setting 5% above and below the purchase price as stop-loss and take-profit points, reducing the stress of constant monitoring.

Negative Balance Protection Mechanism

Regulated trading platforms should offer negative balance protection, ensuring investors can only lose their account funds and will not owe the platform any money. If the account is wiped out, the platform bears the subsequent loss. However, some brokers proactively reduce leverage before major market moves to avoid huge risks.

Final Investment Advice

Investment is fundamentally a game of gains and losses. Before engaging in leveraged trading, fully understand trading principles, master the use of stop-loss and take-profit tools, and establish a long-term, steady investment plan. Liquidation risk is not uncontrollable; it can be effectively managed through discipline, knowledge, and proper tools.