Liquidation refers to when the losses on a position reach a certain level, causing the margin to be insufficient to support the position, at which point the exchange will automatically perform a forced liquidation to protect the interests of the exchange and other traders.
Earlier we mentioned that the underlying logic of contract trading is actually leveraged borrowing. For example, if Little Fish has 100 USDT of investment capital and uses 10x leverage to open a BTC long position worth 1000 USDT, if at this time the price of Bitcoin is 100 USDT, then this transaction essentially borrows 900 USDT to purchase 10 BTC along with the principal, intending to sell it for profit after the price of Bitcoin rises.
However, if the price of Bitcoin falls all the way to 90 USDT each, then the 10 BTC in hand will only be worth 900 USDT at market price, which just equals the amount borrowed by Little Fish. If the price continues to fall, the value of these 10 BTC will drop below the loan amount. The exchange will definitely not let itself incur losses, so when the price of Bitcoin drops by 10%, to 90 USDT each, the exchange will liquidate Little Fish's position, which is what we call 'liquidation.'
After liquidation, users not only lose money, but also the margin (principal) used to open the position will be lost. The higher the leverage used, the easier it is to get liquidated. In the above example, if 10x leverage is used, a 10% price movement in the opposite direction will result in liquidation; if 100x leverage is used, a 1% price movement in the opposite direction will result in liquidation.
The above example calculates liquidation based on a 100% loss, but in actual trading, each exchange calculates the liquidation loss percentage differently; some will calculate it at 90%. Therefore, in specific trading, directly referencing the liquidation price given by the exchange is more accurate.
Spike risk
A spike refers to a sudden and severe fluctuation in the market, followed by a quick return to normal levels. This situation may trigger stop-loss orders or cause liquidation, resulting in losses for investors. Spikes may be due to insufficient liquidity at the exchange or may result from malicious market manipulation.
Funding rate wear
As we mentioned earlier, exchanges now require users holding perpetual contract positions to pay a funding rate every 8 hours. Although each time it's only 0.000x%, if the held position is large and held for a long time, the cumulative funding rate can also become a significant expense.
High contract risk, trade cautiously!
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