CoinEx | Factors Behind Forced Liquidation in Futures
Recently, there has been a big story in the global financial market. Having excited the market for a period, the Fed finally decided to raise the benchmark interest rate by 0.25% on March 16. However, the financial market soared after the interest rate was raised — US-listed stocks surged while China’s A-shares rebounded. What is even more surprising is that cryptocurrencies rose despite the depressing market conditions. According to CMC, the BTC price went up by 4.3% at the peak on March 16.
Many investors have been caught unprepared by the across-the-board surge against a sluggish market. On March 16, many ambitious short traders were liquidated. One investor said on a crypto forum that his position was liquidated even though he set an SL (stop-loss) price, the system did not perform liquidation at the SL price and his positions were eventually liquidated. Such cases are common under extreme market conditions, and you will see why that’s the case once you learn the rationale of forced liquidation. Today, we will focus on forced liquidation in futures.
What is forced liquidation?
When trading futures, you need to pay a small amount of money according to a certain ratio as the security deposit for contract performance, which is called Margin. More specifically, the Margin required for starting your position is referred to as Initial Margin; while Maintenance Margin is a proportion of the position value to keep your position open. Once your Available Margin fails to cover the Maintenance Margin, your position would be forced-liquidated.
Initial Margin and Maintenance Margin are calculated with different formulas.
*The figures are calculated differently across exchanges. Here, we focus on CoinEx.
Initial Margin = Open Value * Initial Margin Rate; Initial Margin Rate = 1 / Leverage * 100%
Maintenance Margin = Open Value * Maintenance Margin Rate
Let’s apply these formulas to practice: Suppose User A selects Cross Margin and longs 1 BTC at the unit price of 40,000 USDT with a 100X leverage ratio, the Initial Margin = 40,000*1/100 = 400 USDT, which is also the minimum Margin that he must pay for starting the position.
According to the tiered system of Maintenance Margin on CoinEx, User A’s Maintenance Margin Ratio stands at 0.5%, which means that the Maintenance Margin = 40,000*0.5%=200 USDT. If his Maintenance Margin falls below 200 USDT, the position would be forced-liquidated.
Why was my position liquidated when I set up an SL price?
Such cases primarily occur during significant market swings, and a position with an SL price is also called a limit order. Though the order is sent to the market when the position price reaches the SL price, it was not executed because the market price was changing rapidly. Under such circumstances, you could change your order into a market order.
How do we mitigate liquidation risks?
The crypto world may suffer in a day fluctuations that the conventional financial market experiences in a whole year. The crypto market changes instantly. Meanwhile, futures trading multiplies the risks through leverage. That said, how do we mitigate the risks and stay away from forced liquidation?
First of all, position management is the key. Starting with a huge position is not advised. Instead, you can keep the initial position below 10% of your available funds. In addition, always remember to set an SL price, which will normally keep your losses within 10%. Losses of over 10% indicate that your trading direction (long/short) is wrong and that you should close your position and make a quick exit. Finally, you should take the profit once your position reaches the target profit. Being greedy may reduce the size of your profit and might event turn profits into losses.
Secondly, you should stay away from the lesser-known cryptos because they often suffer from limited market depth, which means that price slumps may be frequent. In addition, compared with mainstream coins, such cryptos are riskier. Lastly, we should hold the market in awe and create our own trading strategies, letting the head prevail the heart.
*The above content does not constitute any investment advice.