Every trader faces one of the scariest events that may occur in the market – liquidations. The cease of trading order, inevitably resulting in budget loss, is inevitable throughout a trading career.
However, while seeming an absolute negativity, there is more to the notion of liquidation. It is a complex trading tool, securing both investors and exchanges.
As WhiteBIT raises awareness about crypto fears in its latest activity, we take the baton – and spoke with Bryan, a day trader and market analyst with a solid background in DeFi. He shares his personal story about liquidations and shares methods to cope with them based on his own experience.
Below – a compilation of personal reflections and guiding principles every trader should read and be aware of.
Can you walk us through one of your most memorable experiences dealing with liquidations at the beginning of your path (if you had such)? What key lessons did you learn from that?
When I was first introduced to trading around 6 years ago, all I could see was dollar signs. I had no strategy, plan, risk management, nothing. All I knew was that I wanted to do this and the only thing that could stop me is if God himself took me off the planet first.
Now, the Bryan of 6 years ago wouldn’t even be allowed in my trading area now, but I’ll share a “fun” story with you real quick about my first liquidation I’ll never forget. I learned a new SMT concept and I sat down and said “Well, we found the strategy that will make us a millionaire, are you ready for something like that?”. I remember internally telling myself, “well of course, this is why we got involved in trading, to become rich” but if I truthfully recall that day, I remember an underlying nervousness that responded to the question I asked myself. The truth was, I wasn’t even close to being ready or what being ready even meant.
I try to never be judgemental of the people I meet, but I can tell you this: I would have judged 6-years-ago me harder than any person I’ve ever met.
The story of my first liquidation. I sat down at my computer and this was honestly my first ever strategy: “If this candle wicks off this line, I’m going long”. Why that line? Only God knows why. I would soon learn what the next 6 years of my life would be dedicated to. Figuring out why in the world that line didn’t do what I wanted it to do, and how long could I hold on until I lost everything.
I learned two things the first day I was liquidated.
1. I’m stubborn beyond belief
2. I’m starting to think this may take a little more time, and I really don’t know what I’m doing.
As the position began going against me, I was hit with a tidal wave of emotions and memories that I had suppressed for years. Flashbacks of coaches being hard on me when I was in college playing Baseball. Voices of my friends saying “You can’t do this, you need a 9-5 just like everyone else”, etc. Everyone had an opinion of me inside my own head, but that’s exactly what it was, my own mind showing me all the things I needed to improve upon if I wanted to survive in this industry.
I was not only an amateur trader, I was an infant when it came to risk management. I’ll be honest, I don’t think I even fully grasped the concept of leverage (this is horrible to admit, but sometimes the truth is ugly). I was experiencing a baptism by fire as I would refresh the Kraken website to see the -$ continue to fall like a jenga tower until one final refresh displayed a big fat 0. I remember sitting there and staring at the -$ sign turning to flat 0’s everywhere and thinking, “What. Just. Happened.” I was liquidated, the money I had worked hard for had suddenly vanished.
This was the first test of Me Vs Me and I don’t think I even had time to put my name at the top of the test, I had failed faster than anything else in my life. There was a sudden thought of “maybe this isn’t for me” immediately shot down by an internal dialogue of “Keep going and get to work”.
What key factors do you think lead to mass liquidations in the crypto market? Is it purely volatility, or do you see deeper systemic issues?
I think there’s a few factors at play here.
First, the market has no feelings, no true bias against any individual trader. The market acts as a mirror, which will always reflect you and your level of understanding/emotions on the chart.
I think every new trader sees their favorite influencer online with a Lambo and thinks it’s easy. Not everything, but there’s a good chance your favorite trader is making more money off selling courses than they are actually trading.
I think most new traders get liquidated simply because they underestimate this beast. They maybe get lucky on one or two trades and blinding greed takes over to the point where the trader thinks they’re invincible, and before they know it, they’re not following a plan and adding more and more to a position with absolutely no plan of a stop loss.
Do you believe liquidations are an inherent flaw of the leveraged trading system, or are they an essential risk management tool?
Liquidations are an essential tool to the trading system because it’s how other traders are paid. Now there are obviously market makers who supply both sides of the market to ensure traders can go long and short as they see fit, but in order for a trader to make a $30k profit, there needs to be traders somewhere taking a $30k loss, this isn’t the FED, money isn’t being printed out of thin air.
The market maker is likely the one supplying that liquidity for your profit, but rest assured, the market makers are making it up somewhere else on the charts eventually by getting other traders liquidated. I don’t think it’s a flaw as much as it is a necessity.
Are there any common warning signs that traders should look for to avoid margin calls, and how can they protect themselves in volatile markets?
The biggest warning sign is when a trader goes in with only one sided bias. They (traders – author’s note) truly have no plan if the trade goes against them, they’ve made up their mind that it’s going “this direction” and have no plan other than to beg and plead with the charts if it turns against them.
The easiest way to never be liquidated is to swallow your pride and take the loss when it goes against you. Trader’s who don’t take any losses are not called Traders, they’re gamblers. One simple rule to avoid margin is this:
Do not add to a losing position, regardless of how tempting it is. You were wrong for a reason initially, there’s no point in adding more in hopes it turns around. You can choose not to heed this advice, but I will say it’s more of a warning, than advice.
What role does leverage play in triggering liquidations?
Leverage is basically a multiplier/divider on your collateral.
For example, the higher the leverage, the less a trader needs to put up for collateral to get a larger position. However, you can use things like 10x,20x, etc. OR you can use something called “Cross” which uses your entire balance.
For a novice trader, I would always recommend not using “Cross”. Cross means you’re risking your entire account as collateral to protect your position. Is your liquidation price going to be lower? Sure, but if it’s reached, you either need to add more to your account or you’re going to blow the entire account.
At least with 10x or 20x leverage, you have a set amount of collateral that you’re willing to part with if the trade loses. The x multiplier simply means that if you’re opening a $1000 position, you can do so with only $100 in collateral. Now, $100 at 10x leverage may mean if the position goes even $5 against you, it would be treated as $50 against you, and remember you only put up $100 of collateral, so now you’re down 50% of your posted collateral position. If the trade goes against you $10, you’re now likely to have a margin call because your position is down $100 (size of your collateral).
I use these numbers as an example, but obviously things may be different depending on the size of contracts you’re opening and leverage selected. Again, the key to leverage is not seeing it as “look how big of a position I can open” it’s all relative to your collateral and again, why I don’t recommend using “Cross” as that’s leveraging your entire account balance.
Leverage remains a rather dangerous tool for trading. Could you explain the risks of overleveraging in cryptocurrency trading, and why it’s particularly dangerous in highly volatile markets like crypto?
Well, volatility is exactly what it says: if the market is moving sharply in one direction or even both directions, you’re going to be on a roller coaster of emotions if you don’t have a set plan in place. “Where’s my take-profit? Where’s my stop-loss?”
If you don’t have a set target prior to the position opening, then you have no chance against a volatile market. Every new trader goes through this: “I’m not taking profits, it might go higher” and “I mean, I’m down, but it’s going to recover”.
Now add a highly volatile market where you may be up $100 one day and the next day, the market has completely reversed, and you just lost your $100 to liquidations because $100 or 100% profit wasn’t enough for you.
Crypto is still in its infancy and a lot of times these orderbooks can be thin, meaning when it falls, and you’re long, the market is seeking liquidity (traders with no plan in place) in order to balance out funding rates and taking stop losses of traders even with a plan.
Given the rapid growth of decentralized finance (DeFi), how do you think liquidation models will need to evolve to better serve traders and protect platforms?
I don’t necessarily know if liquidation models need to evolve to be better, as much as traders must adapt to the market conditions. I have seen a couple cool features in DeFi that actually allow traders to have a spot position staked earning APR, and auto-repayment of collateral through the interest they earn. This is cool because as you earn through passive income, you can actually begin to pay down some of your debt directly with those “profits”.
For example, long term traders who have a position open may also incur funding fees for keeping their positions open, which also eats into your underlying collateral posted for the position. Having an auto repayment of those fees can be nice to keep your margin at a healthy level on corrections and things like that, but at the end of the day, having a set invalidation point and taking profit will always be essential.
What tools or strategies would you recommend for traders to prevent liquidations, particularly in highly leveraged markets?
The best tool any trader can have is discipline and patience. Without these two virtues, the market will seem impossible and “out to get you”.
One of the greatest lessons I was ever taught was: “The market will be here tomorrow regardless of how you do today, can the same be said about you?”
That really hit me, because when new traders enter the market, they immediately think it’s easy because they saw a friend do it, or they won a trade in the past, and they’re the greatest, thinking, “the market never saw me coming”.
It doesn’t matter how long you trade and are successful, there will absolutely come a day where you have to stare a stop loss and losing trade in the face and are you disciplined enough to take the loss and only lose the amount you decided when the position was initially opened, or will you be undisciplined and “hope” things change.
I can 100% say if you’re “hoping” the market turns around, you will quickly find out your “hope” is a sand castle and a hurricane is hurling down right at you.
Looking ahead, do you think there will be a shift in how crypto traders approach leverage and margin trading due to the high liquidation risks, or will the potential rewards continue to outweigh the risks?
I think trading is a unique opportunity, in that it really separates the disciplined from the undisciplined. Gamblers will always exist, there will always be someone out there somewhere winning on a trade and sharing it on social media, tugging at the emotional strings of everyone who comes across. “This influencer is an idiot, I can do this too”– that enticing feeling of winning is no different than why casinos are successful.
Little did you know, that influencer probably went long on one account and short on the other, completely blew their long account and only posted the results of their short account. This is far more common than most people think. So no, I don’t think crypto traders’ approach will change, unless they decide to change themselves.
How to prepare mentally and strategically for the chance of liquidations. Which precautions could you recommend?
You really shouldn’t even care what the liquidation price is, because your stop loss should be much closer than that number. You should only be using leverage to access more markets at one time. What I mean is that if you have a $1000 account, you could trade maybe 5 markets with the same strategy, but leverage is not there to try and get rich quick, it was designed so you could “leverage” your strategy across multiple markets.
Do you see liquidations more frequently in certain asset classes or trading pairs? If so, why?
I mostly day-trade the futures market now: things like NQ, ES, Gold, etc., so I’m not on the front lines of crypto liquidations much anymore, but liquidations are going to be prevalent in any market that human psychology is involved in.
The undisciplined are fueled by “hope” and “what could be”, while the disciplined trader is fueled by “probabilities” and “what is”. I mean, without a dedicated strategy, you’ll always be gambling. The successful trader stays disciplined and only takes a shot in the market that they have back tested and have already come to terms that hey, this trade may be a loser, but I win 3x as much when I win, so as long as I’m winning more over a long period of time than I’m losing, I can pull actual profit out of these markets.
What advice would you give traders today on how to be prepared for liquidations during periods of market uncertainty?
Always, always, always go in with a plan, your plan should never be. I’ll just risk this collateral to the liquidation point, I can tell you right now with 100% certainty, that if your strategy is “my liquidation price is my stop” you won’t be in the markets long.
Even if you’re initially risking only 1-2% of your account balance per trade, it’s the simple psychological effect of what you’re doing, eventually those intrusive thoughts of “oh this one looks real good, I’m putting more on” will creep in, and your undisciplined nature will lead you to have that same stop at liquidation, and even though you felt great about that trade, it went against you. “But trades NEVER go against me, how could this be? Welcome to the show, kid.
Every successful trader I’ve ever met is beyond humble to some degree, because they’ve walked the pits of hell, they’ve felt the flames of failure over and over, and still chose to get back up and refine their discipline and strategy.
It’s not an easy path, but the person you’ll become is worth more than any dollar you’ll ever make in the market.
