What is Liquidation Price?
Liquidation price is the price level at which a leveraged position will be forcibly closed by the exchange or protocol to prevent further losses. When the mark price reaches the liquidation price, the position is automatically closed, and the remaining margin is used to cover losses and fees. Understanding and monitoring liquidation price is essential for managing leveraged positions.
How Liquidation Price is Calculated
Liquidation price depends on several factors: entry price, leverage used, position direction being long or short, maintenance margin requirement, and any accumulated funding payments.
For a long position, the liquidation price is below the entry price. Higher leverage means the liquidation price is closer to entry. For a short position, the liquidation price is above entry price, and higher leverage pushes it closer.
A simplified formula for a long position: Liquidation Price equals Entry Price multiplied by one minus Initial Margin plus Maintenance Margin. However, actual calculations include additional factors like funding accrued and platform-specific parameters.
Maintenance Margin and Liquidation
Maintenance margin is the minimum margin required to keep a position open. When position losses reduce account equity to the maintenance margin level, liquidation triggers. Different platforms have different maintenance margin requirements, affecting liquidation prices for the same position parameters.
Liquidation Process
When liquidation triggers, several things happen. The position is closed at the current market price or via a liquidation engine. Remaining margin covers losses and liquidation fees. Any excess margin beyond what is needed may be returned depending on the platform. If losses exceed margin, an insurance fund typically covers the deficit.
Liquidation fees vary by platform and are typically 0.5% to 1% of position value. These fees incentivize avoiding liquidation.
Managing Liquidation Risk
Several strategies help manage liquidation risk. Use lower leverage to push liquidation price further from entry. Set stop-losses above liquidation price to exit before forced closure. Add margin to existing positions to lower liquidation price. Monitor positions during volatile periods when rapid price movements can trigger liquidations quickly.