The truth about liquidation in contract trading: Why do smart people also go broke overnight?

Market suddenly crashes, and your position turns from profit to loss within a few minutes, even resulting in your account being wiped out—this is the so-called Liquidation Risk that many investors fear. It not only causes you to lose your entire capital, in some cases it might also leave you in debt. How exactly does liquidation happen? Why is leverage trading so dangerous? Today, we will delve into this issue to help you avoid major pitfalls on your investment journey.

What Is Liquidation Exactly?

The essence of liquidation is that your account net worth falls below the minimum margin requirement set by the trading platform, prompting the system to automatically close all your positions. In other words, when your holdings incur increasing losses and the platform finds you unable to maintain the minimum margin level, it will directly force-close your positions to cut losses, leaving no chance for you to recover.

Why does liquidation happen? There are mainly two reasons:

1. Trading direction is completely opposite — you expect the market to rise but it keeps falling, or you expect it to fall but it keeps rising
2. Serious margin deficiency — your losses have exceeded the minimum margin ratio you can sustain

In simple terms, liquidation means you bet wrong on the market direction, and losses accumulate much faster than expected, ultimately leading the platform to forcibly close your trades.

Five High-Risk Operations That Quietly Lead to Liquidation

1. Setting Leverage Too High

This is the most common culprit behind liquidation. Leverage is like a double-edged sword—it can amplify profits but also double your losses.

For example: you have 100,000 yuan in capital, and open a position with 10x leverage. This means you control a 1 million yuan position. At this point, just a 1% adverse move in the market will wipe out 10% of your capital; a 10% move will likely exhaust your margin, triggering a margin call and a forced liquidation.

Many beginners overestimate their risk control capabilities, believing the market won’t reverse so quickly. But markets always turn unexpectedly fast.

2. Psychological Bias—Refusing to Cut Losses

This is a deadly mistake often made by retail investors. Holding onto losing positions with the hope “it will bounce back soon.” When a gap down occurs and the price plunges sharply, brokers will directly liquidate at market price, resulting in losses far exceeding initial estimates.

3. Hidden Costs Not Fully Accounted For

• Failure to close intraday positions: forgetting to settle the day’s trades, leading to additional margin requirements the next day, causing an immediate explosion if the market gaps open
• Options seller trap: encountering volatility spikes (e.g., major political events), causing margin requirements to double instantly
• Time decay risks: some derivatives lose value over time, which beginners often underestimate

4. Liquidity Risk—Illiquid Assets and Night Trading

Assets with low trading volume tend to have larger bid-ask spreads. Your stop-loss orders may be executed at prices far worse than expected. For example, you set a stop at 100 yuan, but the market only finds a buyer at 90 yuan, increasing your losses immediately.

5. Black Swan Events—Unpredictable Market Crashes

Events like the COVID-19 pandemic outbreak, the Russia-Ukraine war, geopolitical risks… these sudden incidents can cause continuous limit-down drops, market liquidity to dry up, and sometimes even prevent timely liquidation on platforms, leading to margin depletion or even crossing the liquidation threshold (owing platform debts).

Risk Assessment of Liquidation for Different Investment Types

Crypto Trading Liquidation Risks

The volatility in the crypto market far exceeds that of traditional assets, making it a high-risk zone for liquidation. Bitcoin once had a daily fluctuation of 15%, causing many investors worldwide to be liquidated simultaneously.

It’s important to note that when crypto assets are liquidated, not only does your margin disappear, but your purchased coins are also forcibly sold by the platform. This means you lose your money and your holdings are wiped out.

Forex Margin Trading—Playing Big with Small Funds

Forex trading attracts many because it allows small capital to leverage large positions. But the risk of liquidation also increases accordingly.

Three common specifications of forex contracts:

• Standard lot: 1 lot (usually 100,000 base currency)
• Mini lot: 0.1 lot
• Micro lot: 0.01 lot (best for beginners testing waters)

Margin calculation: Margin = (Contract Value × Number of Lots) ÷ Leverage

For example: trading 0.1 lot of a currency pair valued at $10,000 with 20x leverage Required margin = 10,000 ÷ 20 = $500

When your account equity drops to the platform’s minimum maintenance margin ratio (usually around 30%, varies by platform), the system will forcibly close your position. This is commonly known as a “margin call” or “stop-out.”

Real case: An account with $500 balance suffers a $450 loss, leaving only $50. The system automatically triggers a liquidation, ending the trade.

Stock Trading Liquidation Traps

Pure stock trading with own funds is safest Buying stocks with only your own money means even if the stock price drops to zero, you only lose your capital; there’s no risk of liquidation. This is the recommended method for beginners.

Margin and day trading—liquidation traps

• Margin financing: Borrowing money from brokers to buy stocks (e.g., $600,000 in margin for $1 million worth of stocks). When stock prices fall by about 20%, maintenance margin triggers (e.g., below 130%), and a margin call is issued. If you cannot meet the margin call, the broker will directly liquidate your position.
• Failed day trades: If you do not successfully close your position and it gaps down to the limit-down level the next day, you may be unable to sell, leading to forced liquidation, especially if your margin is insufficient.

Three Layers of Protection Every Investor Should Have

First Layer: Stop-loss and Take-profit Settings

Stop-loss (SL) is an automatic order to sell at a preset price. When the market hits your stop-loss price, the system automatically sells your position, preventing further losses.

Take-profit (TP) is an automatic order to lock in gains at your target price. When the market reaches that level, it automatically closes your position to secure profits.

These tools are essential for managing risk per trade effectively.

Key indicator—Risk-Reward Ratio: Risk-Reward Ratio = ((Entry Price - Stop-loss Price)) ÷ ((Take-profit Price - Entry Price))

The lower the ratio, the better. For example, risking 1 yuan to make 3 yuan yields a high value for the trade.

How beginners should set stop-loss and take-profit: Avoid complex technical indicators; use simple percentage-based methods—set a 5% stop-loss and 5% take-profit from your entry price. For example, buy at 100 yuan, set stop-loss at 95 yuan and take-profit at 105 yuan. This way, you don’t need to watch the screen all day but still effectively control risk.

( Second Layer: Negative Balance Protection Mechanism

Regulated platforms should offer negative balance protection, ensuring investors can only lose their account funds and won’t be pursued for additional debts. Even in liquidation, any excess losses are borne by the platform itself.

This mechanism mainly protects beginners, preventing lifelong debt from trading errors. However, some platforms proactively reduce leverage before major market moves for self-protection.

) Third Layer: Portfolio Diversification

• Don’t put all your money into one asset; diversify across different asset classes
• Regular, fixed investments are better than concentrated one-time positions
• Keep enough emergency funds; avoid risking all your assets in one go

Essential Trading Tips for Beginners

Want to entirely avoid liquidation risk?

1. Only buy stocks with 100% own funds
2. Stay away from leveraged products and futures contracts
3. Use fixed regular investments to lower risk over time

If you insist on trading leveraged products:

1. Start with micro lots (0.01 lot) to familiarize yourself with the market
2. Keep leverage below 10x as a beginner
3. Always set a stop-loss—don’t stubbornly hold against the market

Three must-do steps before trading:

• Deeply learn the characteristics and risks of your trading assets
• Practice thoroughly on demo accounts to accumulate experience at no cost
• Develop a trading plan and strictly follow it; don’t alter your strategy due to market emotions

Final Reminder

Investing involves profits and losses. Leverage trading is fundamentally a game of risk versus reward. Entering recklessly without proper preparation and risk management will only lead to liquidation sooner or later.

True experts are not those who earn the most, but those who survive the longest. Protect your principal, control your risks—that is the ultimate goal of investing.