What Is Liquidation?

Liquidation is the automatic closing of your leveraged position by the exchange when your losses approach your initial margin. It's designed to prevent you from owing the exchange money—but it also means you lose your entire margin in seconds.

💀 The Harsh Truth

Every day, millions of dollars in positions get liquidated. Traders watch helplessly as their entire capital vanishes in a single wick. The worst part? Most liquidations are completely preventable.

Why Liquidation Exists: When you trade with leverage, you're essentially borrowing funds from the exchange. If the market moves against you too much, your position would owe more than your collateral is worth. Liquidation prevents negative account balances.

How Liquidation Works (The Mechanics)

The Components

  1. Entry Price: The price at which you opened your position
  2. Position Size: Total value of your position (margin × leverage)
  3. Initial Margin: Your collateral (the money you put up)
  4. Maintenance Margin: Minimum equity required to keep position open
  5. Liquidation Price: The price at which your position is force-closed

The Liquidation Process

Step 1: Price moves against your position Step 2: Your unrealized loss increases Step 3: Your equity (margin - unrealized loss) decreases Step 4: When equity drops to maintenance margin level... Step 5: LIQUIDATION TRIGGERED Step 6: Position force-closed at market price Step 7: Remaining equity (if any) minus liquidation fee returned

Calculating Your Liquidation Price

For Long Positions

Long Liquidation Formula

Liquidation Price = Entry Price × (1 - 1/Leverage) Example - Long BTC: Entry: $40,000 Leverage: 10x Liquidation = $40,000 × (1 - 1/10) Liquidation = $40,000 × 0.9 Liquidation Price: $36,000 Price drop needed: 10% to lose everything

For Short Positions

Short Liquidation Formula

Liquidation Price = Entry Price × (1 + 1/Leverage) Example - Short BTC: Entry: $40,000 Leverage: 10x Liquidation = $40,000 × (1 + 1/10) Liquidation = $40,000 × 1.1 Liquidation Price: $44,000 Price rise needed: 10% to lose everything

Leverage vs Liquidation Distance

How Far Can Price Move Before Liquidation?

  • 1x leverage: ~100% move (no practical liquidation risk)
  • 2x leverage: ~50% move
  • 5x leverage: ~20% move
  • 10x leverage: ~10% move
  • 20x leverage: ~5% move
  • 50x leverage: ~2% move
  • 100x leverage: ~1% move (insanity)

Reality Check: Bitcoin routinely moves 5-10% in a day. Using 10x+ leverage means you're always one normal market move away from rekt.

Real-World Liquidation Scenarios

Scenario 1: The Overleveraged Beginner

Setup:

  • Trader has $1,000
  • Goes long SOL at $100 with 20x leverage
  • Position size: $20,000
  • Liquidation price: $95 (5% drop)

What Happens:

SOL drops 6% to $94 during a normal pullback. Position liquidated. Loss: $1,000 (100%). If they used 5x leverage instead, same move = $300 loss (30%), still in the game.

Scenario 2: The Cascade

The Death Spiral:

  1. Market drops 3%
  2. High leverage traders hit liquidation
  3. Their positions force-sell, creating selling pressure
  4. Price drops another 2%
  5. More liquidations trigger (cascade effect)
  6. Market dumps 10% in minutes

Lesson: Liquidations fuel volatility. During cascades, even conservative positions can get wicked out.

Scenario 3: The Funding Fee Trap

The Hidden Danger:

Trader opens long position close to liquidation price. Doesn't realize funding fees reduce their margin over time. Three days later, funding fees have eaten enough margin that their liquidation price creeps up. Price wicks slightly down (nowhere near original liq price) but hits NEW liquidation price. Rekt.

Lesson: Funding fees move your liquidation price! Always maintain a buffer.

Advanced: Partial vs Full Liquidation

How Most Exchanges Handle It

Modern exchanges often use partial liquidation (or "auto-deleveraging") to minimize losses:

  1. Step 1: Price approaches liquidation level
  2. Step 2: System reduces your position size (not closes entirely)
  3. Step 3: This increases your margin percentage
  4. Step 4: If price continues against you, repeat
  5. Step 5: Only full liquidation if price moves too fast

The Catch: Partial liquidations still lock in losses and reduce your position. Plus, you pay liquidation fees on each partial close.

The 7 Rules to Never Get Liquidated

🛡️ Rule #1: Keep Liquidation Price 20%+ Away

Your liquidation price should ALWAYS be at least 20% from entry. This means:

  • Long positions: Use max 5x leverage
  • Short positions: Use max 5x leverage
  • Never use high leverage just because it's available

🛡️ Rule #2: Use Stop Losses Instead of Relying on Liquidation

Liquidation should be your emergency backup, not your exit strategy. Set stop losses at sensible levels to exit with controlled losses before liquidation risk.

Example Setup: Entry: $100 Stop Loss: $95 (5% loss, calculated position size) Liquidation: $85 (15% buffer below stop) Result: You exit at stop with small loss. Liquidation never reached.

🛡️ Rule #3: Account for Volatility

Don't just think about "normal" moves. Markets have wicks—sudden spikes that briefly hit extreme prices before reverting.

Strategy: Check the asset's 30-day high/low range. Your liquidation price should be beyond even extreme moves.

🛡️ Rule #4: Monitor Mark Price vs Last Price

Exchanges use mark price (a calculated fair price) for liquidations, not the last traded price. This prevents manipulation but can catch you off guard.

Important: During volatile moves, mark price might be different from what you see on the chart. Always check both.

🛡️ Rule #5: Add Margin Before Trouble Starts

Most platforms let you add margin to an existing position, moving your liquidation price further away. Don't wait until you're close to liquidation—add margin proactively if price approaches your comfort zone.

🛡️ Rule #6: Avoid Trading During High Volatility Events

Major news, liquidation cascades, exchange issues—these create extreme volatility. Close risky positions or significantly reduce leverage before:

  • Federal Reserve announcements
  • CPI/inflation data releases
  • Major company earnings (if trading stocks)
  • Weekends (lower liquidity = bigger wicks)

🛡️ Rule #7: Set Price Alerts Way Before Liquidation

Don't rely on watching charts 24/7. Set alerts at:

  • First Alert: 50% distance to liquidation
  • Second Alert: 25% distance to liquidation
  • Final Alert: 10% distance (URGENT)

This gives you time to either add margin, close position, or adjust your strategy.

What to Do If You're About to Get Liquidated

Emergency Triage (Ranked by Priority)

  1. Add Margin Immediately — Increases your buffer, moves liq price away
  2. Close Partial Position — Reduce position size to improve margin ratio
  3. Set Stop Loss — Exit with some capital left vs losing everything to liquidation
  4. Hedge with Opposite Position — Open small counter-position on another exchange (advanced)

❌ What NOT to Do

  • ❌ "Hold and hope" — Price can always go lower/higher
  • ❌ Average down near liquidation — You'll lose even more
  • ❌ Panic sell at the worst time — Use limit orders if possible
  • ❌ Ignore it — Liquidation WILL happen if you do nothing

Understanding Liquidation Fees

Exchanges charge fees when liquidating your position, typically:

  • Taker Fee: ~0.05-0.075% for force-closing
  • Liquidation Fee: Additional 0.5-1% penalty
  • Insurance Fund Contribution: Remaining margin often goes here

Reality: If you get liquidated with $1,000 margin, you might get back $0-50 after fees, not the full maintenance margin. Another reason to NEVER let it happen.

Liquidation Tools & Resources

Essential Tools to Use

  1. Position Calculator: Calculate liquidation price before entering (most exchanges have built-in calculators)
  2. Liquidation Heatmaps: Show where large liquidation clusters exist (helps predict volatile moves)
  3. PerpsTracker Leaderboard: Study top traders and notice they rarely use extreme leverage
  4. TradingView Alerts: Set price alerts at critical levels

Psychology: Why Traders Still Get Liquidated

The Mental Traps

  1. Greed: "10x leverage = 10x profit!" (ignoring 10x risk)
  2. Overconfidence: "I'm sure it won't move against me"
  3. Revenge Trading: Using higher leverage to "make back losses"
  4. FOMO: Entering late with high leverage to "not miss the move"
  5. Ignorance: Not understanding how liquidation actually works

The Fix: Treat liquidation risk like a loaded gun pointed at your capital. Would you play with a loaded gun? Then don't play with high leverage.

Case Study: May 2021 Crypto Crash

💀 $10 Billion in 24 Hours

What Happened:

  • BTC dropped from $58K to $30K in days
  • Over $10 billion in leveraged positions liquidated
  • 400,000+ traders wiped out
  • Exchanges crashed from volume

Who Survived:

  • ✅ Traders with 3x leverage or less
  • ✅ Those with stop losses set
  • ✅ Spot holders (no leverage)
  • ✅ Traders who closed positions early when volatility spiked

Summary: Your Anti-Liquidation Checklist

✅ Before Every Trade

  • ✅ Calculate liquidation price BEFORE entering
  • ✅ Ensure liquidation is 20%+ away from entry
  • ✅ Use 5x leverage maximum (3x for beginners)
  • ✅ Set stop loss between entry and liquidation
  • ✅ Set price alerts at 50%, 25%, and 10% to liquidation
  • ✅ Check upcoming news/events that could spike volatility
  • ✅ Never use more than 10% of capital on one position
  • ✅ Account for funding fees eating into margin

Liquidation is not a "sometimes" risk—it's a mathematical certainty if you trade recklessly with leverage. The top traders on PerpsTracker stay at the top precisely because they respect liquidation risk. Learn from them, not from the liquidated masses.

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