Five Strategies to Minimize Liquidation Risks in Crypto Futures
Futures Trading is a financial instrument that enables investors and traders to control a larger contract value with an expiry date, using a smaller margin amount. Crypto Futures contracts are usually perpetual, meaning they have no expiry date but still possess the characteristics of traditional futures contracts, particularly leverage.
Leverage allows traders and investors to control a larger contract value based on an underlying asset by providing a smaller margin amount. Essentially, it involves the exchange providing a loan against the margin money. For example, if a trader chooses 20x leverage on a BTC/USDT futures contract, they only need to pay $200 as margin money to control a position worth $2000. This is made possible by receiving a loan of $1800 from the exchange.
When taking a leveraged position, the exchange loans the remaining amount for trading and safeguards its own capital by imposing a strict limit on the trade if it starts incurring losses. This is because leveraged positions in futures markets are susceptible to volatility and price fluctuations, which can quickly wipe out a trader’s available balance, leading to a negative balance. In such cases, if the losses exceed the maintenance margin, the exchange overseeing the market initiates liquidation of the trade, often resulting in the trader losing their entire trade position.
Strategies to Minimize Liquidation Risks in Crypto Futures
Stop loss order
A stop loss, also referred to as a “stop order” or “stop-market order,” is an advanced order placed by an investor on a cryptocurrency exchange, instructing the exchange to sell an asset at a specific price point.
To set up a stop loss order, traders must input three key parameters: the stop price, sell price, and size. The stop price is the point at which the stop loss order will execute, while the sell price is the desired selling price for the asset. The size parameter represents the amount of the asset that the trader plans to sell.
If the market price reaches the stop price, the stop order will be automatically executed, and the asset will be sold at the specified price and size. Traders may opt to set the sell price lower than the stop price to increase the likelihood of the order being filled in the event of a rapid market downturn.
The primary goal of a stop loss order is to minimize potential losses. To illustrate this point, let’s consider two scenarios:
Plan your trade
To effectively mitigate liquidation risk, it is essential to meticulously plan your trades in advance. By adopting a well-defined strategy and taking a calculated approach, you can significantly decrease the likelihood of incurring unnecessary losses. Educating yourself about liquidation in the realm of cryptocurrency will further enhance your understanding and ability to manage this risk.
Effective risk and money management
This strategy is crucial for traders to enhance their trading outcomes. By employing a robust risk management strategy, traders can minimize losses incurred from unfavorable trades while maximizing profits gained from successful ones. This approach ensures better decision-making and overall trading performance.
Monitor your margin ratio
A useful way to manage your risk without using a stop order is to manually monitor your margin ratio. This involves calculating the liquidation percentage, which is determined by dividing 100 by your leverage.
For instance, let’s say you open a trade with an initial margin of $100 and a leverage of 5x, which creates a position worth $500. Applying the formula above, your liquidation percentage would be:
20% = 100 / 5
This means that your position would be liquidated if the asset’s price moves against your position by 20%, resulting in a decrease in value from $500 to $400.
By actively monitoring your margin ratio, you can effectively manage your trades and make well-informed decisions regarding when to exit a position in order to avoid liquidation.
Avoid Overtrading
It is crucial to avoid overtrading positions, as adding new positions actually raises the liquidation price for your entire portfolio. Once you have committed to a contract and its value plummets, it is essential to refrain from adding more and more positions just to cover for losses.
Overtrading diminishes the liquidation threshold and heightens the probability of facing liquidation. Instead, traders should prioritize risk management by promptly closing out positions that have incurred losses, rather than attempting to mitigate them through averaging down or acquiring additional contracts. The establishment and adherence to a well-defined trading strategy are pivotal in averting significant losses stemming from impulsive decisions.
Wrapping Up
For traders venturing into cryptocurrency futures, the significance of minimizing liquidation risks cannot be overstated. By employing the five prominent strategies mentioned above, which encompass the establishment of stop-loss orders, cautious avoidance of excessive leveraging, and diversification of your portfolio, you can effectively mitigate the perils of liquidation while enhancing your prospects for triumph within the crypto market.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.
