Forced liquidation is an automatic tool that protects lenders when their risk rises from your failing leveraged trading positions. So keep an eye on them!
Liquidation means to sell assets for money. Forced liquidation means automatically turning assets into currency or its equivalents (like stablecoins) and it’s a mechanism for setting up market orders to get out of leveraged positions. Forced liquidation means that this selling behavior kicks in when certain circumstances arise.
In the cryptocurrency context, if a trader or investor can’t meet the margin requirements for a leveraged position (in margin or futures trading) forced liquidation pulls them out of the trade.
If you get into leveraged trading then you must keep an eye on the liquidation price. If you use more leverage then your liquidation price will be closer to your entry price. Let’s see how this works:
Say you begin with $100. You enter a leveraged long position in the BTC/USDT market with 10x leverage, which makes your position size $1000. $100 of that is yours, and you borrow the other $900. If Bitcoin drops 10%, the position is now worth $900. Any further losses would then apply to the borrowed money. The person who lent you the funds won’t want to risk you losing them any more, which is where the forced liquidation mechanism comes in. The position is automatically closed so the lender gets their $900, and your $100 is lost.
Forced liquidation can be costly, and to add insult to injury there is usually an additional liquidation fee to pay on top. The reason it’s there is to encourage traders to keep an eye on their positions and close them before they end up being closed through forced liquidation. It’s good to make yourself aware of additional risks like this before you get into this kind of trading.
Lots of trading platforms will let you work out your liquidation price before you enter a position, so you’ll have a clear view of your profit and loss, target price, and liquidation price in advance.
Forced liquidation may also be a term that you hear in the context of bankruptcy proceedings, when an entity is made to liquefy their assets.