What is Forced Liquidation?
#Basic
#Futures
#Beginners
1. What is Forced Liquidation?
Forced liquidation occurs when your margin reaches the maintenance margin level, leading to the need for your position to be liquidated, resulting in the loss of all your maintenance margin. When the fair price reaches the liquidation price, forced liquidation is triggered, a process generally referred to as "liquidation."
Forced liquidation typically occurs in futures trading during periods of high market volatility. When asset prices fluctuate significantly, traders' account balances may not meet the maintenance margin requirements. To address this situation, trading platforms automatically initiate forced liquidation according to predetermined rules.
For example, if a user engages in leveraged trading to purchase a certain value of crypto assets but experiences a price drop leading to insufficient margin, the trading platform will automatically sell a portion or all of the position to cover the margin shortfall.
MEXC employs a fair price marking system to prevent forced liquidation resulting from insufficient liquidity or market manipulation.
2. How is Forced Liquidation Carried Out?
2.1 Calculation of Liquidation Price in Isolated Margin Mode
Liquidation Condition: Position Margin + Floating PNL ≤ Maintenance Margin
Long Position: Liquidation Price = (Maintenance Margin - Position Margin + Average Entry Price x Quantity x Size) / (Quantity x Size)
Short Position: Liquidation Price = (Average Entry Price x Quantity x Size - Maintenance Margin + Position Margin) / (Quantity x Size)
Note: Trading fees are omitted here.
2.2 Forced Liquidation in Cross Margin Mode
In cross margin mode, all of the user's available margin will be used as the position margin. However, it is important to note that in cross margin mode, the unrealized PNL of profitable positions cannot be used as margin for other positions.
From the above formulas, we can see that users can increase the distance from the entry price by manually increasing the position margin. Therefore, users facing a higher risk of liquidation can mitigate it by manually increasing their margin.
3. Forced Liquidation Process
When forced liquidation is triggered, the system will proceed in the following order: executing order cancellations, self-trading between long and short positions, tiered liquidation, and then liquidation. This approach enables gradual liquidation based on user risk limits, avoiding full liquidation of all positions and mitigating risk for users.
3.1 Execution of order cancellation: In cross margin mode, all current orders in the account will be canceled. While in isolated margin mode, if automatic margin addition is enabled, all current orders for the futures pair will be canceled. After executing the order cancellation, if the margin ratio is still greater than or equal to 100%, the process continues to the next step.
3.2 Self-trading between long and short positions: Simultaneous cross margin positions in both long and short directions will be reduced by undergoing self-trading (this step is only applicable during the forced liquidation process in cross margin mode). After executing self-trading, if the margin ratio is still greater than or equal to 100%, the process continues to the next step.
3.3 Tiered liquidation: If the user's position is at the lowest risk limit tier, the process proceeds directly to the next step. If the risk limit tier of the user's position is higher than Tier 1, it needs to be lowered. This means a portion of the position at the current tier will be taken over by the liquidation engine at the bankruptcy price, reducing the risk limit tier. Then, the margin ratio is recalculated based on the maintenance margin ratio after lowering. If the margin ratio is still greater than or equal to 100%, the process continues to further lower the risk tier until the lowest tier is reached.
3.4 Liquidation: If the position is at the lowest tier but the margin ratio is greater than or equal to 100%, the remaining position will be taken over by the liquidation engine at the bankruptcy price. (The liquidation takeover process bypasses the matching system, thus the bankruptcy price will not appear in market trade records or K-line charts.)
4. Handling After Liquidation Engine Takes Over Position
When a user's position is taken over by the liquidation engine at the bankruptcy price, if the remaining position can be executed in the market at a more favorable price than the bankruptcy price, the remaining margin will be added to the insurance fund.
If the position cannot be executed at a more favorable price than the bankruptcy price, the loss from liquidation will be compensated by the insurance fund. If the insurance fund is insufficient to cover the loss, the auto deleveraging system will take over the liquidated position.
5. How to Avoid Forced Liquidation
5.1 Increase Margin or Decrease Leverage
You can mitigate the risk of forced liquidation by adding margin or lowering the leverage, which moves the liquidation price away from the market price.
5.2 Set Stop-Loss
Setting a stop-loss price is an effective way to avoid forced liquidation, helping limit losses and prevent orders from being liquidated.
It is important to note that TP/SL orders may fail due to factors such as extreme market volatility or insufficient available position for closure. If triggered successfully, a market order will be placed to close the position, but due to market fluctuations, the market order may not be executed immediately, resulting in deviation from the set price.
5.3 Set Liquidation Alert Notifications
In the preference settings on the futures trading page, enable liquidation alert notifications and set the margin ratio. MEXC will alert you when the margin ratio of a position reaches or exceeds the value you set, with a maximum of one alert every 30 minutes per position.
Summary
The use of leverage tools can help you achieve greater profits but also comes with corresponding risks. When engaging in futures trading, you can avoid forced liquidation by utilizing the tools provided by the platform and adopting rational trading strategies.