How Liquidation Price is Determined

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Definition

The liquidation price in crypto futures trading is the price level at which a trader's margin collateral is exhausted, leading to the automatic closing (liquidation) of their leveraged position by the exchange. This mechanism is crucial for protecting the exchange and ensuring the solvency of the margin system. Understanding how this price is determined is a fundamental aspect of crypto futures trading, which falls under the broader pillar page Mechanics of Crypto Futures Trading.

Why it matters

For traders utilizing leverage, the liquidation price represents the maximum adverse price movement their position can withstand before the initial margin is lost. If the market price reaches the liquidation price, the position is closed, and the trader typically loses their entire margin deposit for that specific trade. Knowing this price helps traders set appropriate stop-loss orders and manage their risk exposure effectively.

How it works

The calculation of the liquidation price depends on several interconnected factors, primarily involving the initial margin, maintenance margin, leverage used, and the current market price.

Margin Requirements

Traders must post an initial amount of collateral, known as the Initial Margin, to open a leveraged position. As the trade moves against the trader, the equity in the account decreases. The Maintenance Margin is the minimum equity required to keep the position open.

Margin Ratio and Health Factor

Exchanges typically use a margin ratio or health factor to monitor the position's risk level. When the equity in the margin account falls below the required maintenance margin level, the health factor drops to zero or below a critical threshold, triggering the liquidation process.

The Calculation

The liquidation price is conceptually the price where the loss incurred by the position equals the initial margin posted, minus any required maintenance margin buffer.

For a simplified long position (buying futures): Loss = Initial Position Value * (Liquidation Price - Entry Price) / Entry Price

The liquidation price is calculated such that the margin used equals the maintenance margin requirement. While the exact formula can vary slightly between exchanges (e.g., depending on whether they use cross-margin or isolated margin), the core principle involves solving for the price at which the margin ratio hits the maintenance threshold.

Isolated vs. Cross Margin

The calculation is significantly affected by the margin mode selected:

Isolated Margin

Only the margin allocated specifically to that position is at risk. The liquidation price is calculated based solely on that position's margin.

Cross Margin

The entire account balance is used as collateral for all open positions. Liquidation only occurs when the entire account equity falls below the total maintenance margin requirement across all positions, often resulting in a liquidation price further away from the entry price compared to isolated margin usage.

Practical examples

Consider a trader opening a long position on BTC/USDT using isolated margin with 10x leverage.

Entry Price: $50,000
Position Size: 1 BTC contract (worth $50,000)
Initial Margin Required (e.g., 10% for 10x leverage): $5,000
Maintenance Margin Required (e.g., 2%): $1,000

If the trader uses $5,000 as initial margin, they effectively control a $50,000 position. A $5,000 loss would wipe out the initial margin. However, the exchange requires the position to be closed before the equity drops below the $1,000 maintenance margin.

In this simplified scenario, the position can sustain a loss of $4,000 before liquidation ($5,000 initial - $1,000 maintenance). The percentage loss the position can withstand is $4,000 / $50,000 = 8%. If the price drops by 8% from $50,000: Liquidation Price approximation: $50,000 * (1 - 0.08) = $46,000.

The actual liquidation price calculated by the exchange engine will be slightly higher than $46,000 because it must also account for fees and the Funding rate cap]] adjustments that might have occurred while the position was open.

Common mistakes

A common mistake is relying solely on the entry price and leverage to estimate the liquidation price without factoring in the specific margin mode (isolated vs. cross) or the exchange's specific margin ratio formulas. Another mistake is failing to account for trading fees and funding payments, which slightly decrease the account equity over time, effectively moving the liquidation price closer to the entry price.

Safety and Risk Notes

Liquidation is a guaranteed outcome if the market moves significantly against an unhedged leveraged position and no stop-loss order is active. Traders must ensure they have sufficient funds in their margin wallet to cover potential drawdowns. Utilizing stop-loss orders set below the calculated liquidation price is a standard risk management practice. High leverage magnifies both potential gains and potential losses, bringing the liquidation price much closer to the entry price.

References

Sponsor	Link	Notes
Paybis (crypto exchanger)	Paybis (crypto exchanger)	Cards or bank transfer.
Binance	Binance	Spot and futures.
Bybit	Bybit	Futures tools.
BingX	BingX	Derivatives exchange.
Bitget	Bitget	Derivatives exchange.