What is Liquidation?
Here's the deal: when you trade with leverage (borrowed money), the exchange will automatically close your position if your losses get too big. This is called liquidation - and it's the fastest way to lose everything in trading.
Think of it this way: leverage is like a loan from the exchange. Liquidation is them calling in that loan immediately because you can't pay it anymore.
In plain English: Liquidation is when the exchange says, "You're losing too much, we're closing your trade NOW," and you lose your entire investment in that position.
How Liquidation Works
The Margin System
When you open a leveraged trade, you need to put up some of your own money as "margin" (collateral).
Example:
- You have $1,000
- You use 10x leverage
- You control a $10,000 position
- Your $1,000 is the margin
- The exchange lent you $9,000
The liquidation trigger:
- If your losses reach close to your $1,000 margin
- The exchange automatically sells your position
- You lose your entire $1,000
- The exchange gets their $9,000 back
Pro tip: Different leverage = different liquidation price. Higher leverage = closer liquidation price = more danger.
The Liquidation Price
Every leveraged position has a liquidation price - the price level where you'll get wiped out.
Real example:
Scenario 1: 10x leverage (conservative)
- Bitcoin at $30,000
- You go long (buy) with $1,000 + 10x leverage = $10,000 position
- Liquidation price: ~$27,000 (10% drop)
- Bitcoin can drop 10% before you're liquidated
Scenario 2: 50x leverage (aggressive)
- Bitcoin at $30,000
- You go long with $1,000 + 50x leverage = $50,000 position
- Liquidation price: ~$29,400 (2% drop)
- A tiny 2% drop wipes you out
Pro tip: This is why high leverage is dangerous. Bitcoin moves 2% in its sleep. You can get liquidated in minutes.
Real-World Liquidation Examples
Example 1: The Bitcoin Drop
Scenario:
- You buy Bitcoin at $30,000
- You use 20x leverage
- Your liquidation price is $28,500
- What happens:
- Bitcoin drops to $29,000 (you're sweating)
- Bitcoin drops to $28,600 (almost liquidated)
- Bitcoin hits $28,500 (POSITION CLOSED)
- You lost your entire investment
- Price then bounces back to $29,500
- But you're already out - you're wrecked
Lesson: If you had no leverage (1x), you'd still be in the trade and profitable. Leverage turned a temporary dip into a total loss.
Example 2: The Ethereum Squeeze
Scenario:
- You short Ethereum at $2,000 (betting it will go down)
- You use 10x leverage
- Liquidation price: $2,200
- What happens:
- Ethereum pumps to $2,100 (you're losing)
- News breaks - Ethereum adoption announced
- Ethereum rockets to $2,300 in minutes
- You get liquidated at $2,200
- You lose everything
- Ethereum keeps going to $2,500
Lesson: Shorts can get squeezed hard. When price goes up rapidly, short sellers get liquidated, which pushes price higher, which liquidates more shorts - it's a chain reaction.
Example 3: The cascade Effect
Scenario: Market-wide panic
- Bitcoin drops from $30,000 to $28,000
- Thousands of overleveraged traders get liquidated at once
- Their positions are automatically sold
- This selling pushes price lower
- More traders get liquidated
- More selling
- Price crashes to $25,000
- All in minutes
Pro tip: This is called a "cascade liquidation" and it's why crypto can crash 20% in minutes. Liquidations feed on themselves.
How to Prevent Liquidation
Strategy 1: Use Less Leverage
The #1 rule: If you can't sleep, your leverage is too high
Safe leverage ranges:
- Beginner: 2-5x max
- Intermediate: 5-10x
- Advanced: 10-20x (still risky)
- Insane: 50-100x (you will probably lose everything)
Pro tip: The best traders use low leverage. They'd rather make 50% on 5x leverage than lose everything on 50x leverage.
Strategy 2: Always Use Stop Losses
Set a stop loss BEFORE your liquidation price.
Example:
- Liquidation price: $28,500
- Stop loss: $28,800
- If price hits $28,800, you lose $200
- If you wait for liquidation at $28,500, you lose $1,000
Pro tip: Stop losses are like eject buttons. Use them before the plane crashes, not after.
Strategy 3: Don't Overtrade
Wrong: Opening 10 leveraged positions with your entire account
Right: Never risking more than 1-2% of your account per trade
Example:
- Account size: $10,000
- Maximum risk per trade: $200 (2%)
- If you get liquidated, you lose $200
- You still have $9,800 to trade with
Pro tip: Size your positions so one bad trade doesn't destroy you. Surviving is more important than one big win.
Strategy 4: Keep Extra Margin
Wrong: Using your entire account balance as margin
Right: Keeping extra funds in your account as buffer
Example:
- Account: $10,000
- Trade uses: $2,000 margin
- Remaining: $8,000 as safety buffer
- If trade goes against you, you have extra margin to survive volatility
Pro tip: The more excess margin you have, the safer you are. Don't max out your account.
The Psychology of Liquidation
Why Traders Get Liquidated
- Greed - Wanting to make money fast, using high leverage
- Hope - "Price will come back, I won't get liquidated"
- Panic - Moving stop losses further away instead of accepting small loss
- Revenge trading - Immediately re-opening position after liquidation to "make it back"
The cycle:
- Get liquidated
- Get angry
- Use even higher leverage to win it back
- Get liquidated again
- Repeat until broke
Pro tip: The best thing to do after liquidation is STOP. Take a break. Review what went wrong. Don't revenge trade - you'll just lose more.
The "Rekt" Phenomenon
In crypto, getting liquidated is called getting "rekt."
Common phrases:
- "I got rekt on that trade"
- "Liquidity cascade incoming"
- "Wen lambo?" → "Wen liquidation?"
Pro tip: If you can laugh about getting rekt, you'll survive. If you take it personally and revenge trade, you'll blow up your account.
Liquidation Calculations
How to Calculate Your Liquidation Price
Long position (betting price goes up):
Liquidation Price = Entry Price × (1 - 1/Leverage)
Example:
Entry: $30,000
Leverage: 10x
Liquidation = $30,000 × (1 - 1/10)
Liquidation = $30,000 × 0.9
Liquidation = $27,000
Short position (betting price goes down):
Liquidation Price = Entry Price × (1 + 1/Leverage)
Example:
Entry: $30,000
Leverage: 10x
Liquidation = $30,000 × (1 + 1/10)
Liquidation = $30,000 × 1.1
Liquidation = $33,000
Pro tip: Most exchanges show your liquidation price. Don't trade if you don't know where it is.
Common Mistakes to Avoid
Mistake 1: Adding to Losing Positions
Wrong: "Price is down, I'll buy more at cheaper price"
What happens:
- You're already losing
- You add more money
- Price keeps going down
- Your entire account gets liquidated at once
Right: Either take the loss or don't add to losers. Adding to losers is how accounts go to zero.
Mistake 2: Moving Stop Losses Away
Wrong: "I'll move my stop loss further back, it'll come back"
Result: Instead of losing 5%, you lose 100% when liquidation hits
Right: Set stop loss and stick to it. If it hits, accept the loss and move on.
Mistake 3: Ignoring Liquidation Price
Wrong: Opening trade without knowing liquidation price
Right: Always know your liquidation price before opening trade. If it's too close, reduce leverage or position size.
Mistake 4: Trading During Major Events
Wrong: Holding leveraged positions during:
- Fed announcements
- CPI data releases
- Bitcoin halving events
- Major exchange news
Why: These events cause extreme volatility. You'll likely get liquidated by the wick.
Right: Close leveraged positions before major events. Or trade smaller size with wider stops.
Pro Tips from Experienced Traders
- Pretend leverage doesn't exist - Trade as if you're using 1x, then slowly add leverage once profitable
- Liquidation is the enemy - Your #1 goal is to not get liquidated. Profits come second.
- Use isolated margin - Don't use cross margin (where one liquidation can wipe your entire account)
- Set alerts - Get notified when price approaches your liquidation level
- Keep a trading journal - Write down every liquidation and what you learned
- Start small - If you're new, use 2-3x leverage maximum
- Respect the market - The market can stay irrational longer than you can stay solvent
Key Takeaways
- Liquidation = total loss - you lose your entire investment in that position
- Higher leverage = closer liquidation - 50x leverage can wipe you out with a 2% move
- Always use stop losses - set them BEFORE your liquidation price
- Never add to losers - averaging down on leverage leads to complete liquidation
- Size matters - smaller positions = less liquidation risk
- Know your liquidation price - before opening any leveraged trade
- Don't revenge trade - after liquidation, take a break, don't try to win it back immediately
- Survival > profits - the goal is to survive long enough to get good
Bottom line: Liquidation is the nuclear bomb of trading. It ends careers and destroys accounts instantly. Use low leverage, set stop losses, and never risk more than you can afford to lose. The market will always be here tomorrow - make sure you are too.
Related Terms
- Leverage - The borrowed money that makes liquidation possible
- Margin Trading - Trading with borrowed funds
- Stop Loss - Your defense against liquidation
- Liquidation Price - The exact price where you get wiped out
- Risk Management - How to avoid getting liquidated