One of the key concepts every trader encounters is liquidation. Let's break down what Bitcoin liquidation is, why it happens, what types exist, and how to reduce the likelihood of it occurring.
Exchange platforms provide Bitcoin traders with additional trading tools that significantly expand their capabilities. These include derivative financial instruments, such as futures and perpetual contracts.
However, at the same time, such instruments increase trading risks, since Bitcoin derivatives most often allow the use of leverage. Leverage is a mechanism that enables a trader to open positions exceeding their capital by using borrowed funds provided by the exchange or broker. For example, with 1:10 leverage and $1,000 of personal funds, a trader can control a $10,000 position.
What is Bitcoin liquidation and what types exist?
Bitcoin liquidation is the process by which an exchange or broker forcibly closes a previously opened leveraged position. This occurs due to insufficient margin to cover losses when the price moves in a direction opposite to what the trader expected.
Liquidation acts as a self-regulation mechanism that helps the market regain balance by eliminating insolvent positions. During mass liquidation, volatility in the markets increases, which can trigger a chain reaction and lead to a sharp collapse or rally of the asset.
It's important to note that a position can be either on asset growth (long position) or decline (short position). In the case of a long position, Bitcoin liquidation occurs when the asset price drops, and for a short position, when it rises.
In trading, there is a concept called the "liquidation level." This metric depends on the size of the leverage. The higher the leverage a trader uses to open a position, the closer the liquidation level will be for Bitcoin.
For example, 10x leverage means that the total trade size is ten times the initial margin (i.e., the trader's balance). In such a case, the liquidation level is reached if Bitcoin's price changes by 10%, and with 100x leverage, by just 1%.
When does Bitcoin liquidation occur and how to avoid it?
Bitcoin liquidation doesn't happen instantly: first, a so-called margin call is triggered. In other words, the exchange or broker first warns the trader that the value of their liquid portfolio is close to the pre-established minimum margin level (i.e., the collateral). If the trader ignores the situation, the platform forcibly closes the position and deducts the funds either in its favor or in favor of another lender.
One way to avoid liquidation is to increase the margin to support the open leveraged position. It's important to understand that there are two types of margin when using leverage:
- Isolated margin, where only the funds allocated to the trade are considered;
- Cross margin, where the entire deposit balance is used as collateral.
In the case of liquidation using isolated margin, the user only loses the amount allocated to the trade, while the rest of the deposit on the exchange remains untouched. However, in a Bitcoin liquidation with cross margin, the trader loses all assets in the account.
Another way to avoid Bitcoin liquidation is to use stop-losses. This means the trader can predetermine an acceptable level of loss. For example, if a trader using 10x leverage sets a stop-loss at 2%, the losses will be five times smaller than if the position were fully liquidated.
Finally, a trader may choose to close a position manually to avoid larger losses. However, in this case, the lost funds cannot be recovered. To reduce risks in the future, it's advised to use low leverage (2x–5x) and allocate only a small portion of the deposit per trade (no more than 2–5%). Additional tools, such as a Bitcoin liquidation chart, can also help reduce risks.
What is a Bitcoin liquidation chart and why is it useful?
Bitcoin liquidation is also a market trend indicator. Analyzing liquidation data allows traders to forecast market behavior. For example, a high volume of liquidated short positions may signal the beginning of a bullish trend — and vice versa.
A liquidation chart (also known as a Bitcoin liquidation heatmap) shows the open positions of traders (both long and short) that are most vulnerable to forced closure.
Here's how it works: the platform aggregates data from various exchanges, then groups them to identify patterns and clusters, and based on that, creates the Bitcoin liquidation chart. The horizontal axis of the heatmap usually represents price levels, while the vertical axis shows intensity or volume.
Where to view Bitcoin liquidation heatmaps online
Several services allow you to track the Bitcoin liquidation heatmap online. These include:
- CoinGlass (Liquidation Heatmap section);
- CoinCapMarket (Data tab);
- The Block (BTC Liquidations page).
It should be noted that Bitcoin liquidation chart data does not guarantee that a trader's predictions will come true, even if they are well-founded. Therefore, it's essential to factor in risks and adhere to basic safety rules in Bitcoin trading.