What Is Liquidation Price?
To get the complete picture of what liquidation price means in relation to what liquidation is and to understand how losses work in leveraged trading I would recommend first reading these guides:
- What is liquidation in leverage trading?
- Can you lose more than you invest with leverage?
- How losses work in leverage trading
In this article, I will break down the concept of the liquidation price which is misunderstood among most beginner traders since the nature of how it is works might seem complicated at first glance.
- Liquidation price is the distance from your entry price to the price where your leveraged position gets liquidated due to a loss.
- The greater the amount of leverage, the shorter the distance becomes from your entry price to your liquidation price, increasing the risk of liquidation.
- The liquidation price can be derived by using a liquidation price formula that is derived from the chosen leverage ratio.
Related: Use our liquidation price calculator to manage your risk.
Liquidation price explained
The liquidation price is the distance from the entry price of your leveraged position to where it gets liquidated.
Remember, a liquidation can only happen in a leveraged market with at least a 1:2 leverage ratio.
At a leverage ratio of 1:2, the distance to your liquidation price will be 50% from your entry price.
This is easy to remember as 1:2 cuts the liquidation price in half, hence the 50% distance.
When trading without leverage, liquidation is not a factor.
Your position can fall indefinitely without leverage, but it can never get liquidated.
Now, below is a chart of BNB/USD to illustrate how liquidation price works at a 1:2 leverage ratio.
The entry price of the trade is $277 and with a 1:2 leverage ratio, the distance to your liquidation price is 50%.
This means that once you reach a loss of -50% with a leverage ratio of 1:2 your position will get liquidated.
As you increase the leverage, the distance from your entry price to the liquidation price shrinks.
- At a leverage ratio of 1:3, your liquidation price will be 33% from your entry price.
- At a leverage ratio of 1:4, your liquidation price will be 25% from your entry price.
- At a leverage ratio of 1:5, your liquidation price will be 20% from your entry price.
You can see how the distance shrinks with the increase of leverage.
This can further be illustrated with a chart/table to show you how the relationship between leverage and liquidation price works.
The table below shows leverage ratios from 1:1 leverage – 1:100 leverage with the corresponding price of liquidation.
For each position, are assume that the trader is trading BTC/USD and the entry price will always be $20.000. From here we get the liquidation price.
|Liquidation distance (%)||–||-50%||-20%||-10%||-6.66%||-5.00%||-2.86%||-2.00%||-1.33%||-1.00%|
To find out the liquidation price for a leverage ratio of more than 1:100 see the formula below.
What is the meaning of liquidation price?
The meaning of the liquidation price is:
- To indicate at which price level your losses would mount up to the total value of your account balance.
- To give a representation of the maximum risk for each leveraged position.
- To help traders adjust their risk profile.
There are two factors that play a big role in why the liquidation price exists in the first place.
This concept would not exist without leverage and how margin accounts function.
When you open a position with leverage you are opening a position that is larger than your total account balance.
Liquidation price is a factor since all your losses are deducted from your margin balance and not the total position size including leverage.
Suppost you have $800 in your forex account and you enter a trade with 1:2 leverage.
This would give you a total position value of $1600 which is twice the size of your initial deposit.
Since your account balance can only cover losses up to $800, your position will get closed out when this loss has been reached, which is at -50% of the total trade value $1600.
On the contrary, when you trade without leverage, your account balance will be able to cover all the losses until the underlying asset falls to literally $0.
What does liquidation mean?
Liquidation is a total loss of funds due to outsized losses.
A liquidation happens when your overall losses exceed your total account balance.
This is a way for the forex broker or the leveraged trading platform to prevent you from going into debt and losing more than you have in your account.
Without the liquidation feature, most traders who used leveraged accounts would lose a lot more money.
How liquidation works
Liquidation is an automatic process that is controlled and executed by the broker.
Once your margin requirement hits 0% and your asset price has reached the liquidation price all your open positions are closed ut and all your funds in your account are lost.
Once the liquidation is in process, your open positions will be sold back to the market with a market order.
Before a liquidation, the trader will receive a warning signal called a margin call.
This warning is meant to warn the trader that the open losses are close to reaching the full value of the account.
If nothing is done to prevent further losses the account will get liquidated once the losses reach the threshold.
Examples that describe liquidation price
I will give you two different examples that describe this concept.
In the first example Trader A will use a leverage ratio of 1:25 and in the second example, Trader B will use a leverage ratio of 1:175.
Trader A is trading Bitcoin with a leverage ratio of 1:25.
The current price of Bitcoin is $19,419.
If we use the same formula as above the liquidation price, in this case, would be:
100 / 25 = 4%
$19,419 x 0.04 = $776.50
$19,419 – $776.50 = $18,642.50
Trade B is trading the Nasdaq index with a leverage ratio of 1:175.
The current price of Nasdaq is $10,652.
We use the same formula to figure out the liquidation price, here is the result:
100 / 175 = 0.57%
$10,652 x 0.0057 = $60,70
$10,652 – $60,70 = $10,591.30
How to prevent leverage account liquidation
There are several ways to prevent liquidation depending on what market and what kind of broker you choose.
Here are my best tips:
- Use a stop loss – A stop loss is a protective risk management tool that prevents further losses from happening. With a stop loss you can choose the maximum loss per position either with a dollar value or with a percentage value.
- Trade with a lower leverage ratio – If you have read this article fro the top you will begin to understand that the risk of getting liquidated increases with increased leverage. Thus, using a lower leverage ratio will significantly reduce the chances of getting liquidated. This is why we have created these guides:
- Use isolated margin when possible – Isolated margin is a way of isolating all losses to one position only. When isolated margin is used, only that one position can get liquidated. This prevents the whole account from getting liquidated from one bad trade. Most crypto leverage trading platforms and exchanges offer these security features but also some CFD brokers and forex brokers.
- Trade fewer markets – When trading fewer markets it is easier to maintain control over your positions and your losses. Beginners traders who trade several markets at the same time with high leverage ratios usually suffer more frequent liquidations.
- Learn how to calculate leverage – By calculating your leverage before you enter the market you can set yourself up for success. This is one of the best ways to control your positions and risk in general. Use our calculators below to calculate your margin requirements.
How to figure out liquidation loss
There are two ways of find out the liquidation loss.
It can either be an account-wide liquidation or a position liquidation.
- Full account liquidation – If your total account suffers a liquidation then the total loss will be the amount that you have deposited into your account.
- Position liquidation – If your position gets liquidated then the total amount is the margin requirement that went into opening that position.
If your total account balance is $800 and your whole account gets liquidated then your total loss is $800.
However, if your total account balance is $800 but you only use $200 as margin requirement and your position gets liquidated then your total loss would be $200.
Can you get liquidated in spot trading?
No, it is not possible to get liquidated in a spot market since there is no leverage attached to the positions.
Only a leveraged position can get liquidated.
Positions in spot trading can fall in price and lose as much as 99.99% until the value of the asset literally hits zero in value.
To understand this concept further read our guide: