Cryptocurrency futures are a type of derivative that investors can trade on the cryptocurrency market. Many people may not be aware of what a derivative is and why it’s important to understand them before trading in this market.
In this article, we will discuss what liquidation is and how you can avoid it as an investor. We’ll also take a look at exactly when the liquidation mechanism starts for any given futures contract, so you know when you need to start preparing to either hedge your position or take profits off the table!
What Is Liquidation?
Liquidation is the process by which an investor’s position in a contract is closed out. Think of it as “selling your shares” or “closing out your position” with respect to futures contracts on cryptocurrency exchanges. This typically happens when there are not enough funds to cover what you owe after your trade and can lead to hefty losses for investors who don’t understand how they work! The big thing to understand here is that liquidation occurs at the behest of an exchange.
This means that if you don’t have enough funds in your account or cannot transfer sufficient currency over to cover it before the price drops below a certain point (as defined by exchanges), this process begins. At first, you will get margin calls that require you to pay more money into your trading platform so long as there’s still time before settlement occurs.
You can see how close we are getting towards expiration in our crypto futures contracts! If after all of these measures fail and prices continue dropping, then investors who hold positions on their contract could be forced out due to lack of liquidity. This may seem like something only large players need to concern themselves with, but it’s actually something that can happen to even novice traders. If you don’t pay attention and monitor your position closely enough while trading in this market, then there is a chance you could get liquidated out of the game before prices move back up!
Now that we’ve covered what exactly liquidation means when it comes to cryptocurrency futures contracts on exchanges like BitMEX or Deribit let’s take a look at some ways for you to avoid getting forced out by fluidity issues.
How to Avoid Liquidation When Trading Crypto Futures Contracts?
As an investor wanting to protect their hard-earned money from potential losses due to lack of liquidity (or margin calls), here are three things you should do:
- Don’t attempt risking amounts more than what you can afford to lose: This one may sound like a cliché, but it’s important to remember that there is always the chance of losing money when trading in this market. This means not putting too many eggs into your basket so as to avoid being forced out by lack of liquidity should prices move against you on any given contract. If things are getting really bad and margin calls aren’t doing anything for you anymore, some profits would have been made up until that point, which will somewhat soften the blow. Doing this also ensures that while losses do happen from time to time due to unforeseen circumstances (and they will), more often than not, people who invest responsibly come out way ahead over long periods of investing. That being said, there are instances where even the most responsible of traders could get caught off guard. This is why it’s important to always monitor your positions closely and be ready for anything!
- Don’t use too much leverage when trading: Leverage makes sense if you plan on using it responsibly but can otherwise lead to unnecessary losses due to a lack of liquidity in a position. If this happens, investors will have no choice but to close out their position at whatever price they cannot lose money (if any). The lower prices go, the more likely an investor might be forced out by low liquidity unless they manage things properly from that point onwards early enough before settlement takes place. Using just enough leverage to trade different contracts is key to avoiding this unfortunate scenario. Lastly…
- Know your risk management strategy and stick with it: This means knowing what will happen if prices drop by X% while holding a certain position or if they rise/fall beyond Y%. Knowing these things beforehand can help you make better decisions about the market moving forward. Investors who aren’t able to do this may find themselves forced out of their positions due to a lack of liquidity before expiration occurs. When dealing in crypto futures contract markets like BitMEX or Deribit, making sure that you’re always prepared for anything is the best way to avoid getting in over your head.
Just by doing these three things alone should be enough for you to protect yourself when trading cryptocurrency futures contracts online! If all else fails, however, at least some profits will have been made up until that point, which means only a portion of the investment was lost instead of 100%. This is why proper risk management and monitoring one’s positions closely are so important.
If traders do this from the beginning, before ever putting any money on the line, they’ll quickly see how much safer crypto futures markets can be compared with traditional ones. Investing responsibly may seem scary or daunting given everything we’ve seen happen in recent years, but that doesn’t mean that it’s impossible to do if one follows the rules above.
What about the Liquidation Mechanism: When does it start?
The liquidation mechanism for any given position starts as soon as the maintenance margin level has been breached. In the case of XBTUSD, BitMEX uses a 2% initial margin requirement and a maintenance margin requirement of 25%. This means that as soon as prices fall below 2%, then there is a possibility that liquidation will occur.
For every 1% that the price falls, an additional 2% of leverage is drained from the trader’s account until they are left with just 25%. That being said, traders can set their own levels for liquidation, which allows them to trade within their own comfort zone. In this regard, BitMEX gives traders quite a lot of freedom.
If you want to be more conservative about it and not let your positions ride too far past that mark, then just set your liquidation level beforehand accordingly. This way, you can guarantee that there won’t be any surprises from the market at any time since you’ll already know what to expect if a certain price happens to be breached. It’s all up to you and where you want to draw the line for yourself.
That being said, it is always recommendable setting it as low as possible so that maximum gains are made within the shortest amount of time possible. This is because BitMEX charges an insane amount of fees on each position held overnight, which will eat away at potential profits until they eventually become zero! For this reason alone, many traders opt to keep their positions open 24/7 (including weekends) to make the most out of their investments, even though such a decision may increase the chances for liquidation.
There you have it! You now know everything there is to know about the basics behind cryptocurrency futures and how they work, so why not give them a shot? Point to remember: Note that, there are potential risks involved when trading any type of financial instrument. There is only so much information one can learn from reading blog posts like this one before actually needing to put some skin in the game to get a feel for how things work.
This brings us back full circle to why proper risk management is so important! By keeping losses small while allowing winners to run, traders will be able to improve their profits over time while minimizing the risk of liquidation.
Charles Normandin is an experienced essay writer service provider. He can speak up to three languages proficiently and is fond of volunteering, drawing, and rock climbing. Charles believes that the days he spend helping animals at the shelter makes their life better. Meet him on Twitter @Charles60104524.