Complete Guide to Liquidation Risks: Recognize the Dangers, Master the Defense, Invest with Confidence

The biggest fear when trading with leverage is watching your account funds evaporate in an instant. This terrifying scenario of being forced to cut positions, losing everything, or even owing a huge debt is called “liquidation”. How exactly does liquidation happen? Why are high leverage trades especially prone to triggering it? And how can risk management tools be used to hit the brakes in an emergency? This article explains everything thoroughly, teaching you how to protect your hard-earned money!

What is liquidation? Why does it hit this minefield?

Liquidation simply means you made the wrong move, suffered losses so severe that you can’t cover the margin, and are forcibly liquidated by the broker. When your principal (net worth) falls below the broker’s minimum margin requirement, the system automatically closes all your positions for settlement—there’s no chance to turn it around.

Why does liquidation happen? There are mainly two reasons:

• Wrong market direction judgment, going against the market trend
• Losses are so large that the margin is wiped out (equity falls below the maintenance margin requirement)

In simple terms, liquidation is the “desperate moment” that investors fear most.

The five biggest traps that easily trigger liquidation

1. Opening too high leverage

This is the most common culprit of liquidation. Leverage is like a double-edged sword; it can amplify gains but also magnify losses.

Example: Using NT$100,000 principal to open 10x leverage, equivalent to a NT$1,000,000 position. At this point:

• A 1% adverse move in price results in a 10% loss of principal
• A 10% move wipes out almost all capital and may trigger a margin call

Many investors start with overconfidence, thinking they can fully control the risk, but market changes are often faster than expected. Carefully assessing leverage is the first line of defense against liquidation.

2. Holding onto “It will rebound if I wait” mentality

This is a classic mistake among retail traders. Relying on luck and refusing to cut losses, they face gap-down crashes, and brokers will sell at market price, resulting in losses far exceeding expectations.

3. Ignoring hidden costs

Common situations include:

• Not closing day trades, forgetting that holding positions incurs additional margin requirements, leading to a gap-down the next day and potential liquidation
• Selling options and experiencing volatility spikes (like during elections), causing margin requirements to double suddenly

4. Liquidity traps

Playing less popular assets or trading during after-hours can easily cause issues:

• Wide bid-ask spreads, resulting in stop-loss orders executing at unreasonable prices
• For example, aiming to stop loss at NT$100, but the market only trades at NT$90 with someone willing to buy

5. Black swan events

Unexpected events like the COVID-19 pandemic or Russia-Ukraine war can cause continuous limit-downs, making it impossible for brokers to close positions. Ultimately, margin is wiped out, debts accrue, and there’s a risk of being forced to cover at a loss.

How big is the liquidation risk across different assets?

Cryptocurrency liquidation

Cryptocurrency markets are highly volatile, making them high-risk zones for liquidation. Bitcoin once experienced daily swings of up to 15%, directly causing many investors to be liquidated. Especially when trading with leverage, not only can the margin be wiped out, but the coins purchased can also disappear.

Forex liquidation

Forex margin trading is a game of using small amounts of money to control large positions. There are three contract sizes:

• Standard lot: 1 lot
• Mini lot: 0.1 lot
• Micro lot: 0.01 lot (best for beginners)

The margin calculation is simple: Margin = (Contract size × Number of lots) ÷ Leverage

Example: Using 20x leverage to open 0.1 lot of currency (worth US$10,000) ➤ Required margin = 10,000 ÷ 20 = US$500

When your account margin ratio drops below the platform’s minimum (usually 30%), the broker will forcibly close your position, known as a “margin call.” For instance, if you have US$500 left but lose US$450, leaving only US$50, the system will automatically close your position.

Stock liquidation

Trading stocks with cash is the safest: Using 100% of your own funds to buy stocks means that even if the stock price drops to zero, you only lose your principal and won’t owe the broker.

But with margin and day trading, there’s a risk of liquidation:

• Margin buying: When the maintenance ratio drops below 130%, a margin call is issued. If you don’t add funds, your position is liquidated (e.g., using NT$600,000 of margin to buy NT$1,000,000 worth of stocks; a 20% drop in stock price hits the margin call threshold)
• Failed day trades: If you don’t close positions and the market gaps down the next day, you might not be able to sell, and the broker will forcibly close your position.

How should beginners get started?

Three tips for absolute beginners: 1️⃣ Start with “cash stocks” — buy stocks with your spare money, so you won’t wake up to a forced liquidation 2️⃣ Avoid “leverage products” — futures, contracts, etc., for more experienced traders 3️⃣ Use a steady strategy — dollar-cost averaging is 100 times safer than going all-in

If you really want to try contract trading: 1️⃣ Start with micro lots — trade 0.01 lot to get familiar with the market 2️⃣ Keep leverage low — recommend below 10x for beginners 3️⃣ Always set stop-loss — never fight the market blindly

Use risk management tools to defend against liquidation

Risk management tools are like a trading life-saving device, helping you control exit timing more effectively.

Stop-loss and take-profit are the most basic defenses

Stop-loss (SL) is setting an “automatic sell price.” When the price drops to this level, the system automatically sells for you, preventing further losses.

Take-profit (TP) is setting an “automatic profit-taking price.” When the price reaches your target, it automatically locks in gains.

These two features are crucial—they help you maintain discipline and control risk, preventing total loss in one go.

Risk-reward ratio determines if a trade is worth doing

Simply put, it’s about “making more than you risk.” The lower the ratio, the more attractive the trade—for example, risking 1 dollar to make 3 dollars.

Risk-reward ratio = (Entry price - Stop-loss price) ÷ (Take-profit price - Entry price)

How to decide stop-loss and take-profit levels?

Experienced traders look at support/resistance lines, moving averages(MA), and other technical indicators. For beginners, a simple “percentage method” works—set 5% above and below your entry price. This way, you don’t have to watch the screen all day; stop-loss when needed, take profits when the time comes.

Negative balance protection is an essential safeguard

Under regulation, exchanges are required to provide negative balance protection. Simply put, you can only lose what’s in your account; you won’t owe the broker a huge debt. If losses reach bottom, the remaining bad debt is absorbed by the broker.

Some brokers proactively lower leverage before major market moves to prevent huge losses. This safety mechanism mainly aims to protect beginners, giving newcomers some room to make mistakes.

Final reminder

Investing involves both gains and losses. Leveraged trading requires extra caution to avoid wiping out your account. Before trading, learn proper trading knowledge, use risk management tools to set stop-loss and take-profit, and lay a solid foundation for long-term investing. Remember: protecting your principal is always the top priority.