The liquidation level is the price at which the broker forcibly closes out a trader's position to prevent further losses. First, there's usually a warning in the form of a margin call to deposit more funds that haven't been met. The broker determines the threshold before a client begins trading in a margin account.
Key Takeaways
- The liquidation level, normally expressed as a percentage, is the point that, once reached, will start the automatic closure of positions.
- The liquidation level is usually predetermined by the brokerage firm.
- Liquidation levels are typically associated with margin accounts for foreign exchange (forex) and cryptocurrency trading, but they apply to any securities traded on margin, including stocks and other securities.
- The liquidation level is a fail-safe or risk management feature that protects traders and dealers from taking on significant losses beyond a specific point.
Understanding the Liquidation Level
The liquidation level is a predetermined point at which an automatic liquidation process begins. The broker may issue a margin call first, so the liquidation level isn't reached. This differs from the "liquidation margin," which is the value of everything in an account should it be closed. Here's how it works:
- Margin requirement: When you open an account that uses leverage, you must maintain a certain amount of money. This margin serves as collateral for what's borrowed.
- Maintenance margin: The broker sets a maintenance margin level, the minimum amount of equity (account balance plus or minus any unrealized gains or losses) that must be maintained in the account to keep the positions open.
- Margin call: Before reaching the liquidation level, the broker may issue a margin call, alerting you that what's in your account is fast approaching the maintenance margin level. You must then deposit more funds or close some positions to avoid liquidation.
- Liquidation level: If the market moves against your positions and the amount in your account falls below the maintenance margin required, you might reach the liquidation level. At this point, the broker won't need your permission to close some or all of your open positions to prevent further losses for both you and them.
The liquidation level is a risk management tool brokers use to protect themselves and their clients from the potentially devastating effects of leveraged trading. It's crucial for traders to understand how liquidation levels work and monitor their accounts closely to avoid involuntary liquidation of their positions.
A typical margin account requirement is for clients to have at least 25% of their own money compared with the total market value of their positions at any given point, though it's often higher.
Liquidation Level as Risk Management
The liquidation level helps manage risk and was developed to protect traders and dealers from significant losses beyond a preset limit. When a trader's account funding reaches the liquidation level, all positions the trader holds will automatically close at the best available rate. The levels that can trigger this action depend on the broker.
Trading in currencies and securities often calls for the use of leverage. The initial upfront trading amount, known as the margin, is needed to access the foreign currency market. If there's extreme market volatility, wide price swings can result in a rapid succession of margin calls and significant losses.
When a dealer handles trades for clients on their behalf, the dealer is taking on the risk of potential losses should the traders lose money. Another risk to the dealer is that the trader won't be able to repay the borrowed funds used to initiate their trades. The liquidation levelprotects the dealer and trader and assures dealers that they have mitigated their exposure to potential losses.
Are Liquidation Levels Only Used in the Forex Market?
Liquidation levels are most commonly used when trading in currencies, including on cryptocurrency exchanges. However, they are used for all accounts with margin, including those for securities trading.
What Price is Used When a Trader's Position Is Liquidated?
If a liquidation level is reached and a trader's positions are closed, the trades will occur at the best available price when the positions close. If the market is volatile or prices fall quickly, the trades can take place at a lower-than-expected price, leading to larger losses than anticipated.
Are There Liquidation Levels for Non-Margin Accounts?
Brokers typically do not set a liquidation level for accounts that do not use margin. However, traders can use stop-loss orders to sell if a cryptocurrency or currency price falls to a specific point, which accomplishes something similar.
The Bottom Line
Liquidation levels serve as a safeguard for traders who use leverage and the broker that offers the leverage. The amount that a trader can lose is limited by automatically closing a forex or cryptocurrency position if it falls below a set level. However, in some cases, market volatility can cause a position to close even if it would regain its value shortly. Before trading, it's important to understand the liquidation level, if any, of your positions.
FAQs
The liquidation level is the price at which the broker forcibly closes out a trader's position to prevent further losses. First, there's usually a warning in the form of a margin call to deposit more funds that haven't been met. The broker determines the threshold before a client begins trading in a margin account.
How does the liquidation process work? ›
The liquidation of a company happens when company assets are sold when it can no longer meet its financial obligations. Sometimes, the company ceases operations entirely and is deregistered. The assets are sold to pay back various claimants, such as creditors and shareholders.
What are the 3 types of liquidation? ›
What are the three different types of liquidation?
- Creditors' Voluntary Liquidation. ...
- Compulsory liquidation. ...
- Members' Voluntary Liquidation (MVL) for solvent companies.
The formula, Liquidation price=Entry price1+(Leverage×(1−Initial margin ratio))Liquidation price=1+(Leverage×(1−Initial margin ratio))Entry price, incorporates entry price, leverage, and initial margin ratio. This informs traders of the point at which their position will be automatically closed.
What happens when you get liquidated? ›
In essence, liquidation in trading refers to the process of converting assets into cash or cash equivalents by selling them on the market. This process specifically involves closing positions, either voluntarily by the trader or forcibly by the broker, usually triggered by a margin call.
Who will be paid first in liquidation? ›
Secured creditors are paid first as they are usually those who have security over some or all of the company assets.
What is the order of payout in liquidation? ›
Who gets paid first when a company goes into liquidation?
- Secured creditors with a fixed charge.
- Administrator/Liquidator fees.
- Preferential creditors.
- Secondary preferential creditors (expanded to include HMRC for certain taxes)
- Secured creditors with a floating charge.
- Unsecured creditors (including all other HMRC debt)
The company will stop doing business and employing people. The company will not exist once it's been removed ('struck off') from the companies register at Companies House. When you liquidate a company, its assets are used to pay off its debts. Any money left goes to shareholders.
What is the final step of liquidation? ›
The end result of the liquidation process is the sale of a company's assets in order to pay its creditors, a process that ultimately leads to the company being closed down and struck from the Companies House register.
How long does liquidation take? ›
Liquidators have to sell assets, conduct investigations and file all paperwork, which can take up to two years, if not longer. The larger the liquidation, the longer the process lasts. During compulsory liquidation, the time between the initial threat and end-of-court procedures can take around three months.
The liquidation level is a predetermined point at which an automatic liquidation process begins. The broker may issue a margin call first, so the liquidation level isn't reached. This differs from the "liquidation margin," which is the value of everything in an account should it be closed.
How do you estimate liquidation value? ›
The liquidation value is calculated by subtracting the liabilities from the auction value, which is $750,000 minus $550,000, or $200,000. Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. Learn how it is calculated and when to use it.
Why is my liquidation price going up? ›
The liquidation price may also change due to funding rate Taking into account the formula of liquidation, the Margin Balance may also be impacted if there is a change in the Wallet Balance. The funding rate is usually a small percentage of the position size but can be larger in times of volatility.
Who pays for liquidation? ›
These costs are usually covered by the company's assets. However, if there are no company assets or cash available, directors may need to pay from their personal funds.
Why is liquidation bad? ›
disadvantages to Liquidation
Any employees will lose their jobs and so will the directors. Shareholders may have to repay illegal dividends (not paid out of profit). Overdrawn directors loan accounts will have to repaid. Suppliers and creditors will lose money.
What is liquidation in simple words? ›
Liquidation is a process in which the company is brought to an end. Also, the assets and property of the company are redistributed to the creditors and owners. Liquidation is also referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation.
How long does the liquidation process take? ›
Liquidation procedures can take anywhere from three months to a year, due to a number of factors including approving liquidation, appointing a liquidator, the sale of company assets and agreeing on creditors claims. Unfortunately, there is no legal time limit on business liquidation.
What is the process of liquidating? ›
Liquidation is a process in which the company is brought to an end. Also, the assets and property of the company are redistributed to the creditors and owners. Liquidation is also referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation.
Who gets paid last during a liquidation? ›
Shareholders are often among the last creditors to receive liquidation proceeds. Preferred stock equity holders receive preferential treatment over common equity holders. Common Equity Shareholders. Common equity shareholders often receive the lowest level of priority.
Will I get my money if a company goes into liquidation? ›
Insolvent liquidation occurs when a company cannot carry on for financial reasons. The overall aim of an insolvent liquidation process is to provide a dividend for all classes of creditor, but it is often the case that unsecured creditors receive little, if any, return.
