Understanding what it means to liquidate your position: The risks you need to avoid

When you invest with borrowed money, there’s a constant threat that can wipe out your gains in seconds: forced liquidation. If your position is liquidated, you not only lose your invested capital but may also incur debt. Understanding what it means to liquidate your position is essential for any investor working with leverage. Markets can be unpredictable, and if you’re unprepared, liquidation can become your worst financial nightmare.

What happens when your position is liquidated?

Liquidating a position means your assets are sold automatically without your consent. This occurs when market price changes generate losses that exceed the available funds in your account. Unlike a voluntary sale where you decide when to close, liquidation is a forced closure controlled by the financial intermediary.

Imagine you want to invest in cryptocurrencies but only have limited capital. Many investors borrow money from brokers or trading platforms to amplify their potential gains. This borrowed money is called leverage. If the market moves in your favor, your profits multiply. But if the price crashes, losses also escalate dramatically, triggering the automatic liquidation mechanism.

Two different ways to close positions

There are two fundamental ways to liquidate a position, and it’s crucial to distinguish them. The first is active liquidation, where you voluntarily decide to sell your assets to secure profits or limit losses. In this case, you have full control over when and at what price you sell.

The second is passive or forced liquidation. This is the dangerous scenario. Here, the trading system automatically closes your position without your approval when losses reach a certain threshold. It’s like the broker telling you: “I can’t allow you to lose more of my money, so I will sell everything right now,” even if you disagree.

Conditions that trigger forced liquidation

For forced liquidation to occur, two conditions must be met simultaneously. First, you must be trading with money that isn’t entirely yours. Part of your position must be financed with borrowed funds. The remaining funds you own are called margin or collateral.

Second, your investment losses must exceed the margin available in your account. Each trading platform sets a specific liquidation threshold. For example, if you deposit $50,000 of your own money and borrow an additional $50,000 (using 2x leverage), your available margin is $50,000. If your investments lose more than that amount, the platform will trigger an automatic close.

However, there is a solution before this happens: you can add more margin to your account at any time. If you deposit additional funds before reaching the liquidation point, you can avoid forced closure. Many experienced traders keep emergency reserves precisely for this situation.

Liquidation is not the same as a loss

This is a critical point many investors confuse. Losing money in conventional investments is different from liquidation. If you invest your own money in stocks and the price drops, you experience an unrealized loss. You can hold those assets indefinitely, waiting for a recovery. Even if the company declares bankruptcy, you retain the option to wait or sell later.

But with liquidation, that flexibility doesn’t exist. Once your position is liquidated, the sale is final and immediate. Moreover, if the price drops so quickly that emergency selling doesn’t generate enough money to cover your debt to the broker, you’ll end up with a real debt that you must pay out of pocket.

For example, if you borrow $100,000 and the market crashes so sharply that your position can only be sold for $95,000, you now owe $5,000 to the broker. This is completely different from a normal investment loss.

Strategies to protect yourself from liquidation

The best defense against liquidation is to use leverage conservatively, or better yet, avoid it entirely if you’re a beginner. If you truly need to invest, do so only with money you can afford to lose completely.

Never borrow from professional intermediaries unless you have a clear strategy and sufficient emergency funds. If the money comes from friends or family without formal terms, the risk is different: you’ll lose the money, but there won’t be forced liquidation of your assets. However, this doesn’t mean it’s safer; it means you’ll face other consequences.

Set clear loss limits before opening any leveraged position. Consider using automatic stop orders to limit your exposure. And remember: once your position is liquidated, the loss is permanent. There’s no hope for recovery—only the reality of lost money and possibly incurred debt.

Liquidation of positions is one of the biggest dangers in leveraged trading, but it is entirely avoidable if you make informed and conservative decisions with your capital.