Liquidation is the forced closure of a leveraged or derivative position by a trading platform when the available collateral is no longer sufficient under its risk rules.

The primary cause is an adverse price movement that creates losses and reduces the equity supporting the position.

How liquidation works

When collateral approaches the critical threshold defined by maintenance margin, the platform may begin closing the position. The exact process varies by exchange: a position may be closed completely or partially, and the exchange may use its own risk-management mechanism.

The price level associated with the risk of forced closure is called the liquidation price.

Why leverage increases risk

With high leverage, a relatively small percentage move in the market can produce a large loss relative to the trader’s collateral. As a result, the distance between the current price and liquidation price generally becomes smaller as leverage increases.