What is a Margin Call and Liquidation in Cryptocurrency Trading?
The invention of leverage and complex trading products like CFDs, for instance, opened the floodgates for traders, irrespective of trading experience.
Using leverage increases the purchasing power of traders, meaning they can open larger lot sizes.
Say Bitcoin trades at $30k; all a trader needs to 'own' 1 BTC is $60 in a margin account and employ leverage of 500X. Exchanges like CryptoAltum make this possible.
By employing leverage to trade, a trader 'margin trades.'
Suppose from a margin account a trader bets for BTC/USD to increase by 'longing,' but his/her prognosis is wrong, and instead, prices fall. In that case, the trade will remain open provided the account has the minimum funds required to keep that trade open—even with losses.
Based on the above example, if prices continue to decrease and funds fall below the threshold, the exchange will liquidate by closing the position at spot rates in a 'margin call.'
A trader can avert a margin call by adding funds to keep the position open.
Margin calls highlight the advantages and disadvantages of using leverage.
On one hand, a trader reaps more profits if his prognosis is correct.
On the other hand, the trader will bear all risks if his/her bet is wrong, further highlighting the need to always employ the correct risk management practices.