When you are liquidated in a trade, your funds actually flow to the counterparty or market system that manages the trade. Here’s how it works:
To put it plainly, when you are 'knocked out' of a trade, meaning you are liquidated, your money goes directly into the pocket of the person trading against you or the system managing the trade. How does this work? Let me explain in detail:
What is liquidation?
It occurs when the money (or margin) in your account is insufficient to cover the losses you incur in leveraged trading, and the system steps in to help you close the trade to prevent further losses, both for you and to protect the exchange or your counterparty from suffering losses.
Who ends up with the money?
Counterparty: If someone is trading against you in your transaction (for example, in the futures market), the money you lose becomes their profit. For instance, if you bet that Ethereum (ETH) will rise and it falls, then the person betting that it will fall earns money from you.
Exchange or broker: Many times, the exchange will charge you a fee when liquidating your position, and they keep that money for themselves. This may include liquidation penalties, closing fees, and so on.
Insurance fund: Some platforms (like Binance or BitMEX) have an insurance fund to prevent significant system issues. If your losses exceed the margin you provided, this fund will help cover the difference.
Why does this happen?
Liquidation is meant to ensure that trading platforms can sustain themselves and do not go bankrupt due to leveraged trading. Since you are trading with borrowed money, if you lose too much, the exchange must close your trade to recover the money you owe them.
How to avoid liquidation?
Use less leverage: If the leverage is too high, even a slight price movement can lead to liquidation.
Set a stop-loss point: Determine in advance when to exit, so you won’t incur excessive losses.
Monitor your margin: Keep a close eye on your margin levels; if they are insufficient, add funds quickly to avoid being automatically knocked out.
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