The cryptocurrency market is known for its extreme price volatility. From Bitcoin and Ethereum to stablecoins, these fluctuations have always been part of this market. This characteristic has made investing in this space riskier compared to other financial markets. One of the significant risks in margin and futures trading is the phenomenon of liquidation, or the total loss of capital.

Since, in some cases, recovering from these losses is extremely difficult or even impossible, understanding prevention strategies for liquidation is of great importance for traders. In this article, we will first examine what liquidation is and then explore methods to avoid it.

What is Liquidation?

Liquidation is a key concept in the cryptocurrency market, referring to the forced sale of crypto assets to prevent further losses, especially during market crashes. In the world of crypto, this term is typically used to describe the automatic closure of a trader’s positions due to a severe decrease in their margin (capital).

This event usually occurs in leveraged trading when the losses exceed the allowed limit, and the trader's capital cannot cover them. In such cases, the exchange automatically closes the trade to prevent further losses. This process can lead to the loss of part or even all of the trader's capital.

Types of Liquidation

• Partial Liquidation: In this case, the trade is closed, and the trader only loses a portion of their capital.

• Complete Liquidation: This happens when a sharp price drop causes the trade to close, and the trader loses all their capital.

When Does Liquidation Occur?

Liquidation happens when an exchange or broker is forced to close a trader's position because they are unable to meet the margin requirements. When the margin balance in the trader’s account falls below the level previously agreed upon with the exchange, the exchange automatically liquidates positions. In this situation, if your leveraged position reaches the liquidation threshold, you will face a margin call, indicating that you need to deposit more funds into your account.

Liquidation typically occurs in futures contracts, where traders use high leverage to increase the value of their position. For example, imagine you enter a trade with $1,000 using 10x leverage, meaning your position is worth $10,000. If the price of Bitcoin drops by 10%, your position will be worth $9,000. If the downward trend continues and your losses increase, the exchange will liquidate your position to protect the borrowed funds. In this case, your position will be closed, and your initial $1,000 investment will be lost.

Methods to Prevent Liquidation:

To avoid liquidation, using capital management techniques can be highly effective. Here are some of these methods:

Don't Invest All Your Capital in the Market
One of the common mistakes in the cryptocurrency market is that some individuals, especially those with less experience, invest all their capital in trades. It is recommended to only invest a portion of your capital in trades until you are familiar with the market trends and conditions. This way, if your analysis turns out to be wrong, you won’t suffer significant losses.

Have a Trading Strategy
One of the best ways to prevent liquidation is to have a clear trading strategy. By having a strategy, you can follow a defined path and avoid being swayed by market emotions. The cryptocurrency market offers various strategies that you can choose from based on your own circumstances and experience.

Use Low Leverage
While high leverage can increase your profits, the likelihood of liquidation also rises in proportion. Since the cryptocurrency market is highly volatile, using low leverage can be more reasonable. This is particularly important when you are new to the market and have little experience. Even the smallest mistake could result in losing your capital, and there is no way to recover this loss or negotiate with the exchange.

Avoid Investing in Unknown Cryptocurrencies
With the increase in the number of cryptocurrency projects in recent years, there are many options available to users. However, you should be cautious about cryptocurrencies that have risen due to marketing or market hype and lack real value. These currencies can quickly lose their value and may lead to liquidation of your trading account. It is better to invest in currencies that have more history and credibility.

Use Stop-Loss and Take-Profit Orders
One of the most effective methods for success in financial markets is setting stop-loss and take-profit orders. A stop-loss helps you sell an asset when its price reaches a certain point, preventing further losses. Setting a take-profit means that you sell your asset at a specific price to secure profits, as some profitable trades may quickly shift from an upward to a downward trend. Setting these limits helps you avoid large losses and make better decisions in critical situations without letting emotions influence your actions.