If you have ever opened a futures trade or tried to quickly sell an altcoin, you have already encountered what is called liquidity. And if you used leverage and "suddenly" lost your entire deposit - congratulations, you are also familiar with liquidation.

What is liquidity?

Liquidity is how easily you can buy or sell an asset without significantly impacting the price.

Simple example:

  • You want to sell Bitcoin for $84,896.

  • If you can do this immediately and the price is not fluctuating, it means the market is liquid.

  • And if you sold and the price immediately dropped by $500 or more, that indicates low liquidity.

How to assess liquidity:

  1. Trading volume - more volume = more money is circulating.

  2. Spread (the difference between buying and selling price) - the smaller it is, the healthier the market.

  3. Order book depth - shows how many orders are at different levels. The more there are, the easier it is to trade without slippage.

What is liquidation?

When you open a leveraged trade, you are borrowing from the exchange. If the price moves against you, the exchange will not allow you to go into the negative. Instead, it will forcibly close your position to protect its money.

This is liquidation - the moment when your trade dies and your collateral (margin) is burned.

Example of liquidation

Let's assume:

  • You opened a long position on BTC at $84,896 with a leverage of x10.

  • Your deposit is $1,000. This is 10% of a position of $10,000.

  • If the price falls by about 10%, your deposit will be wiped out.

  • The exchange will close the position to avoid losses - liquidation will occur.

How is the liquidation price calculated?

The formula is approximately as follows:

  • For long:
    Liquidation price ≈ Entry × (1 - 1/Leverage)

  • For short:
    Liquidation price ≈ Entry × (1 + 1/Leverage)

Example:
You entered a long position at $84,896 with a leverage of x10.
The liquidation price will be approximately $76,406.
(More precisely - taking into account fees and funding, but the essence is the same.)

What are the dangers of liquidations?

  1. Complete loss of collateral.

  2. Emotional stress. Especially if the market then reverses.

  3. Cascade of liquidations. When many traders are liquidated simultaneously - the price drops abruptly, like dominoes.

How to avoid liquidations?

  • Use a stop-loss. This is your insurance policy.

  • Don't be greedy with leverage. Leverage of x3-x5 is already fine. x20 is a gamble.

  • Watch the liquidity. In thin altcoins, liquidations can happen even on small movements.

  • Think strategically. Don't trade on emotions and "gut feelings."

Liquidity vs Liquidations

  • Liquidity is the blood of the market. The cleaner and larger it is, the easier it is for traders to operate.

  • Liquidation is the exchange's protection and punishment for poor discipline.

Don't confuse one with the other: liquidity is your ally, liquidation is your enemy if you don't know how to manage risks.

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