Before you start trading cryptocurrency futures, there are many rules and probabilities to take into account. However, the main rule of success is a carefully thought out strategy for each trade and the calculation of capital at risk.
When trading futures on cryptocurrency assets, traders can use leverage, so it is especially important to know how much capital and borrowed funds are involved in a transaction. This will allow you to analyze the total amount of risk.
This information is very important because in some cases, losing trades can be liquidated.
What is Cryptocurrency Futures Liquidation?
Traditionally, “liquidation” means the conversion of assets into cash. In Bitcoin futures trading, liquidation should be avoided as much as possible as the market is extremely volatile.
When trading cryptocurrency futures, losing positions are forcibly closed in order to avoid a negative balance on the trader’s account. Leveraged positions are affected by volatile prices, which can quickly cause a trader’s account balance to go negative.
In such cases, the losses may be greater than the maintenance margin. As a result, losing trades are liquidated. This happens automatically and compulsorily if the transaction begins to meet certain price criteria.
Liquidation is slow or fast, depending on the amount of leverage in the transaction. So with a small leverage, liquidation will not occur if there is a slight correction in the market. Conversely, high leverage can quickly drain traders’ initial investment.
When does the liquidation mechanism start?
A forced liquidation process will be triggered if an investor or trader no longer meets the margin requirements for leveraged positions.
Let’s take a simple example. Let’s say you want to open a $ 100 trade in a leveraged BTC / BUSD long position. You have 20x leverage, so your position is worth $ 2,000. If the BTC price falls by only 5%, it will completely wipe out the $ 100 initial margin. The margin call requirement to save the trade will not be met and the position will be in danger of being liquidated.
This is a simple example. However, it is important to be aware of your limits, understand how much you are willing to lose in a deal, and strategically use leverage. This is especially important when you are dealing with volatile cryptocurrencies. As such, we have set a leverage limit for new accounts to protect new users from the effects of high leverage.
Crypto exchange Binance believes that all customers should fully understand how leverage works and become familiar with the circumstances under which it can significantly reduce the likelihood of profitable trading. Find out more about ways to reduce your risk of liquidation in our reference materials.
Three ways to prevent liquidation
There are ways to help you avoid liquidation. Traders should remember that losses in transactions are always possible, and they do not have to be accompanied by liquidation.
There are simple tools to prevent this scenario, as well as useful trading strategies that include controlling margin, using stop loss orders, or reducing leverage.
Use stop loss
The most obvious answer to the question of how to avoid liquidation is to set a stop loss above the liquidation price.
A stop loss is a trading tool available on most exchanges that allows traders to set a price to automatically sell if the price of an asset falls to or rises above a set price. A stop loss combined with a liquidation calculator allows traders to protect funds from losses, especially liquidation.
Of course, you can lose some of your funds, but a stop loss will protect you from losing all your capital and from having to pay a liquidation commission. Who wants to lose money and still pay a fine for it? Stop loss allows you to avoid this scenario.
Reduce your leverage
Leverage has a significant impact on the length of a trade. High leverage may seem very attractive, but low leverage is always safer. High leverage can really bring some serious profits. However, it can also increase losses.
We have already said that high leverage can harm a trader even with a slight price change. Using low leverage will help you trade easily and safely in the volatile cryptocurrency market.
Keep track of the margin ratio.
Another opportunity for traders is related to the monitoring of the margin ratio. If the margin ratio reaches 100%, the position will be liquidated. To avoid this, traders can add margin to the trade and cut the position (by reducing the leverage). This method is similar to holding a position when the ratio approaches 100% (if the trade continues to go in a losing direction).
The extra margin or reduction in leverage can be compared to starting with a lower leverage. The difference is that you can maintain a certain margin ratio for a longer time, and besides, this is a more effective solution.
How do I trade futures contracts on Binance?
Trading futures contracts on Binance is pretty straightforward. To gain access to the platform, you need to register on the official website of the exchange https://binance.com.
How to start trading crypto futures on the exchange:
- Open a futures trading account with Binance. Please note: Two-Factor Authentication must be enabled in order to fund your futures account and trade on Binance Futures. You can learn more about opening an account here.
- Deposit funds in USDT, BUSD, or any other available cryptocurrency on Binance Futures. Binance Futures supports a wide variety of cryptocurrency assets as collateral.
- Select the desired futures contract. There are two types of Bitcoin futures available on Binance: USDⓈ-M and COIN-M futures. So, if you want to trade BTCUSDT perpetual contracts, go for USDⓈ-M futures. For BTCUSD coin-margin contracts, choose COIN-M futures.
- Choose the appropriate leverage for your futures contract.
- Choose from one of the order types available on Binance Futures. Newbies can choose a limit order or market order to buy their first futures contract.
Liquidation is a terrible word. Traders do their best to avoid it. The good news is that there are several tools and trading strategies to avoid liquidation. Stop losses, liquidation calculators, leverage and margin monitoring – traders have many resources to avoid liquidation.
Liquidation is just one part of the learning to trade process. Want to know more? Binance offers everything a trader could need for responsible trading. In addition to this article, on Binance Academy, you can explore best trading practices and learn more about trading terms and tools. Also check out our in-depth guide to trading on Binance Futures.