What a liquidation actually is
A position closed at a price you did not choose, at a moment you were not watching, and the resulting balance was lower than the arithmetic on the closing price suggested.
A liquidation is not a special kind of event with its own physics. It is the venue submitting orders to close a position because the account backing it no longer meets a threshold. Everything surprising about it comes from three things: which price the threshold is measured against, that the closing order is an ordinary order subject to ordinary book conditions, and that the process has costs of its own.
This post describes the mechanism. It says nothing about whether anyone should hold a leveraged position or at what size, which are not questions a description of plumbing can answer and not ones this site addresses.
A threshold, not a price
Positions on a margined venue are backed by collateral. Two numbers govern them.
Initial margin is what must be posted to open a position of a given size. Maintenance margin is the minimum that must remain to keep it open, and it is a smaller figure.
Liquidation triggers when the account’s equity — collateral plus unrealised profit and loss — falls to the maintenance requirement. It is not triggered by a price; it is triggered by a ratio, and the price is only one of the inputs.
That distinction has a practical consequence people find counterintuitive: the “liquidation price” an interface displays is a derived figure, computed from the current state, and it moves when anything else in the state moves. Adding collateral moves it. Realising profit elsewhere in the account moves it. A change in the venue’s margin requirement for the instrument moves it, without the market doing anything at all.
Why the reference is the mark price
The comparison uses the mark price, not the last traded price, and the reason is protective — the same reason funding and unrealised profit and loss reference it. If liquidations keyed off the last print, a single aggressive order into a thin book could push the local price through a level and trigger positions that a manipulation-resistant reference would not have touched.
The consequence is worth repeating because it is the single most consequential surprise in the instrument: the price on the chart in front of you is not the price your liquidation is measured against. A visible wick may not trigger anything. An index move that did not print locally may trigger everything.
What the venue does with the position
Once the threshold is crossed, the venue submits closing orders. Several variants exist and they are not equivalent.
Full liquidation. The whole position is closed. Partial liquidation closes only enough to restore the account above the maintenance requirement, so the position survives at a reduced size and can be liquidated again.
Liquidation into the book. The closing order is a real order against the live book, and it walks levels like any other. The fill is whatever the book gives it. Liquidation at a set price with a takeover is the alternative: some venues take the position over at a defined price and manage the exit themselves, so the account’s result is fixed by the rule rather than by the fill.
The thing to notice about the into-the-book case is that the outcome depends on the state of the book at that moment. A forced close is an aggressive order arriving during exactly the conditions that produced the liquidation, when depth is likely to be thin and spreads wide. It pays the full walk. Most venues also charge a liquidation fee or penalty on top, distinct from ordinary trading fees, which funds the machinery below and makes the forced route more expensive than closing voluntarily.
When the close does not raise enough
There is a gap between the price at which liquidation triggers and the price at which the collateral is entirely consumed — sometimes called the bankruptcy price. That gap is the buffer inside which the venue has to complete the close. If the market moves through it before the close completes, the position ends at a loss larger than the collateral behind it, and something has to absorb the shortfall. Two mechanisms exist.
An insurance fund. A pool, generally accumulated from liquidations that closed better than their bankruptcy price and from liquidation fees, drawn on to cover shortfalls. It is a buffer, not a guarantee, and it can be depleted.
Auto-deleveraging. When the fund cannot cover the shortfall, the venue closes positions on the opposite side of the market to absorb it — selecting them by a published ranking. Participants selected this way have profitable positions closed for them, at a price set by the rule, having done nothing wrong and having no warning beyond whatever indicator the venue publishes. The mechanism can therefore reach accounts that were never at risk, and it is a documented feature rather than a failure.
The mechanism
THE MECHANISM — a forced close
· Equity falls to the maintenance
requirement
→ liquidation triggers. A RATIO
crossed, not a price touched.
· The comparison price
→ mark price, not the last local
print. The chart is not the
reference.
· The closing order
→ an ordinary aggressive order into
a live book. It walks levels and
pays impact.
· A liquidation price in the interface
→ DERIVED and moving. Collateral or
margin-rule changes move it with
no market movement at all.
· Close completes inside the buffer
→ collateral absorbs the loss, plus
a liquidation fee or penalty.
· Market moves through the buffer first
→ shortfall. Insurance fund, then
auto-deleveraging of PROFITABLE
positions on the other side.
· Margin requirements, partial-versus-full
logic, fee size, fund policy and ADL
ranking
→ VENUE-SPECIFIC. Every element of
this differs, including whether
ADL exists.Worked example
Illustrative figures, synthetic throughout, chosen for round arithmetic and not describing any real venue’s requirements.
Suppose a long position of 1 unit opened at a mark of 40,000, with 4,000 of collateral posted, and a maintenance requirement of 0.5% of notional — so 200 at this size.
Equity is collateral plus unrealised result: 4,000 + (mark − 40,000). Setting that equal to the 200 maintenance requirement gives a mark of 36,200. That is the trigger.
Setting equity to zero gives a mark of 36,000 — the bankruptcy price. The buffer between trigger and bankruptcy is 200, or half a percent of notional. Everything the liquidation process must accomplish has to happen inside a 200-wide window.
The ordinary case. The mark reaches 36,200, the venue submits a sell for 1 unit, the book absorbs it at around 36,180 after impact, and a liquidation fee is applied. The account ends with a small remainder rather than nothing, and the position is gone.
The gap case. The mark reaches 36,200 during a fast move and the closing order fills at 35,900 — beyond the bankruptcy price. The collateral covers the loss to 36,000 and there is a shortfall of 100 which the account cannot fund. The insurance fund covers it, or auto-deleveraging closes a short position elsewhere to absorb it.
What a liquidation is not
Not a stop-loss. A stop is your instruction with your chosen trigger. Neither is protection, but a liquidation is not even an instruction — it is the venue acting under its own rule, at a threshold it defines, referencing a price it computes. Not a guaranteed exit price either: the trigger is defined and the fill is not. And not necessarily the end of the position, since partial liquidation leaves it open at a reduced size and the process can recur.
The failure mode
The characteristic error is treating the displayed liquidation price as a floor you have located. It is a computed consequence of the current state, it references a price you are not watching, and the close it initiates is an ordinary order into whatever book exists at that instant.
Three ways that bites, all documented behaviour rather than malfunction: the trigger can be reached by an index move that never printed on the venue whose chart you are reading; the fill can land beyond the bankruptcy price, so the loss is bounded by your collateral only because a fund or other participants absorbed the rest; and a position with no margin problem at all can be closed by auto-deleveraging because someone else’s liquidation ran out of buffer. Every part of that is discoverable in advance from whichever venue holds the position, and none of it is visible in the chart.