Long liquidations occur in margin or derivatives trading when a trader’s long position falls below a certain margin maintenance threshold, triggering an automatic forced sale of the underlying asset by the exchange or protocol. The primary purpose is to prevent the trader’s account balance from falling below zero and to ensure that the lender of the leveraged capital recovers their funds.
Mechanism
The mechanism is initiated when the market price of the asset held in a long position drops to a predetermined liquidation price. This price is calculated based on the initial margin, maintenance margin, and the leverage applied. Upon reaching this threshold, the trading system automatically executes a market sell order for the entire long position, or a portion thereof, to cover the margin shortfall. This process often incurs liquidation fees and can contribute to cascading price declines in volatile markets.
Methodology
From a systemic perspective, long liquidations serve as a critical risk management component for leveraged trading platforms, maintaining solvency and protecting lenders. For traders, understanding the methodology involves calculating liquidation prices and implementing strategies like collateral management or dynamic hedging to avoid forced sales. In crypto markets, these liquidations can be particularly impactful due to high volatility and leverage, creating significant price acceleration events often tracked by market participants as a sentiment indicator.
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