Forced liquidation is a process that occurs when an investor's assets are automatically sold off to cover a debt or meet a margin requirement. In the world of cryptocurrency trading, this typically happens when someone uses borrowed money to make trades, also known as leveraging. If the value of the investment drops significantly, the platform or lender will sell off the investor’s assets to prevent further loss and to recover the borrowed funds. This ensures that the lender is protected from potential defaults.
When you trade with leverage, you are essentially borrowing funds to increase the size of your position. For instance, if you start with $100 and leverage it 10 times, your trading position becomes $1,000. However, if the market moves against you and your losses approach your initial $100, a forced liquidation might be triggered. This is because the platform wants to ensure it can recover the borrowed $900 before the position incurs further losses. As a result, your position is automatically closed, and you lose your initial investment.
Forced liquidation is a safety mechanism used by trading platforms to manage risk. While it protects lenders and the platform, it can be a harsh lesson for traders who don’t fully understand the risks of leveraged trading. It highlights the importance of monitoring your trades closely and being aware of the margin requirements and liquidation thresholds set by your trading platform. Understanding these elements can help you manage your investments more effectively and avoid the sudden loss of funds due to forced liquidation.