Blow Up

Definition
Forced liquidation generally occurs in financial markets such as stocks, foreign exchange and futures. Due to rapid market changes, the value of an investment can fluctuate. If an investor fails to add a margin deposit to their account accordingly, for a variety of reasons, the value of the investment would be too different from the value when the time the position was opened. In that case, a margin deposit would be unable to cover the loss of the account, and there will be a forced liquidation. Forced liquidation is also commonly seen in margin trading and contracts trading in cryptocurrency markets. When forced liquidation occurs, the assets in the account will be liquidated; the investor will lose all the principal.

Process:
1. The price fluctuates, and the trend of the price goes the opposite way as expected.
2. The account suffers losses, and the value of the funds in the account decreases.
3. The corresponding leverage increases, and the amount of losses the account can bear decreases.
4. The price continues to fluctuate, and the investor has not increased the margin deposit within the corresponding time limit.
5. The margin deposit can no longer cover the losses; the forced liquidation occurs.

The causes of liquidation

Here are some of the many causes of forced liquidation.

1. No stop-loss. If an investor does not set up a stop-loss price, and does not react quickly when the price fluctuates, there might be a forced liquidation.
2. Large positions with high leverage. If an investor holds a large amount of assets in a position and trades with high leverage, even a slight fluctuation in the price could lead to the forced liquidation in a short time. For example, if an investor chooses 100x leverage, forced liquidation will happen when the price fluctuates 1%.
3. Insufficient margin deposit. If the investor does not deposit additional funds in the margin accounts when the price fluctuates, a forced liquidation could happen.
4. A Black Swan event occurs. If there is an unexpected event that occurs in the market, the price could greatly fluctuate and cause force liquidation.

The difference between liquidation and forced liquidation

Similarly, liquidations also take place in common financial markets such as foreign exchange, stocks, futures, etc. However, liquidation is a trading activity which investors use to close the position spontaneously, for instance, if the investors buy-in at an advantageous price, he or she can sell it to liquidate the assets and vice versa. Liquidation is actively uted by investors themselves for stop-loss or stop-earning purposes. As opposed to forced liquidation where the liquidation is uted by the exchanges and the investor will lose all the principal.

How to prevent forced liquidation

First of all, investors can use risk management tools when trading, such as stop-loss orders. Also, investors should pay attention to the change of positions and make sure to deposit additional margin when necessary. What is more, investors should trade with the appropriate leverage. Lastly, investors should understand the trading rules of different exchanges or platforms and be cautious when investing.