Margin trading is rapidly growing in popularity as more people discover its ability to help them outgrow their initial investment capital. Even small-time traders can jump into the big leagues and open large trades by funding only the initial margins. For example, one can borrow at a 3:1 (3x) ratio on an initial deposit of 1,000 USD and still be able to manage a position worth 3,000 USD.
Unfortunately, margin trading also comes with significant risks. Many crypto users are not careful when it comes to leverage, leading them to experience liquidation at some point in their trading careers. While a correct market prediction can increase one’s profits, an incorrect prediction often results in greater losses.
This lesson will explain liquidation within the context of margin trading. You can also read the following lessons for more beginner knowledge on margin trading:
What is liquidation?
Liquidation is one of the risk management mechanisms exchanges like Huobi Global use to protect traders from significant losses. It is an automatic and forced closing of a trader’s position that prevents their accounts from falling into negative equity. Liquidation happens if a position lacks the funds required to keep a leveraged trade open.
With liquidation, the exchange closes the position, meaning the trader loses at least part of their invested assets. The liquidation loss depends on the initial margin of a trade and the severity of the price decline. Without the liquidation feature, traders would not only lose all their money, they would also have to repay even greater loans.
How does liquidation happen?
Traders experience liquidation because their positions no longer meet margin requirements. The margin is the percentage of the total trade value an exchange requires for a deposit to open a position. If the value of a trader’s margin account drops below the margin, the exchange will start liquidating his positions.
A trader should keep an eye on the following metrics in margin trading to avoid the liquidation:
Risk rate: When the risk rate exceeds 110%, the exchange will force your account into liquidation to repay the price of the loaned tokens and the incurred interest.
Calculating the risk rate
You can use the following formula to calculate the risk rate of your margin account. You can also monitor the visual representation of the risk rate from the meter on the Huobi Global margin trading interface.
Calculation: Account risk rate = Min (current holdings, holding ceiling) / (amount borrowed + interest rate) x 100%.