« Why most liquidation procedures rob you of your money

November 17, 2020 • ☕️ 4 min read

Ever had a leveraged position with a futures exchange/broker?

Did you ever consider how they liquidate positions?

Most brokers and exchanges maintain a minimum equity requirement. 

For trading pairs that support up to 100x leverage, the minimum requirement is usually 0.5% of your position size. 

Once the equity on your position drops below this requirement, the following two things happen:

  • You lose all of your remaining equity
  • Your lose your position.

This is unnecessary and unfair for you

Your position is far from being bankrupt. You still have enough equity in the position to cover a price move of 0.5%.

Let’s pretend for a second that your position is a Long position.

The price can drop a whole 0.5% before your equity becomes negative, and you start owing your broker money.

There is no guarantee that the price will drop 0.5%.

The price might as well rise again. In that case, your position ought to return to normal.

When you lose your position at 0.5% equity, you are being robbed.

When you lose all of your remaining equity at 0.5% equity, you are being robbed.

Your position still has plenty of time to return to normal. The price still has plenty of time to come back up past your liquidation price.

By having your entire position liquidated prematurely, you are giving away 0.5% of your position size for free.

Or rather, it’s being stolen by your broker.

If your exchange or broker does this, run away.

You do not want to trade on a platform that is okay with stealing your money.

The majority of the top exchanges and brokers will be doing this. They do it because it’s profitable for them. They just care about their profits — not about you.

We will refer to this liquidation procedure as “total liquidation”.

asset 1

What should happen instead

Instead of losing all of your equity at 0.5% equity, your position should temporarily enter what we call read-only mode.

Being in read-only mode means that you can’t submit new orders on the position and you can’t cancel existing orders. The control of the position will be temporarily transferred to the broker.

Your broker should then try to save your position. They can do so by selling off a small percentage of it. They usually have an automated system in place that does this automatically.

A 10% reduction in position size is usually enough to bring your equity back above 0.5%. Your position then returns to normal. Your position exits read-only mode, and you regain control of it. Your position is considered saved. 

With this procedure, your equity remains 100% with you. You do not lose all of your equity.

We we will refer to this procedure as “partial liquidation”.

Can I still lose a small amount?

You may lose a small amount of equity when 10% of the position is sold in the market — but it will be more like 10% — and not 100%, like in the other approach.

Your position may also not need to be reduced in size at all. It may just happen that the price just briefly drops below your liquidation price. After a few seconds, it comes back up again.

In that case, your position will briefly enter read-only mode. Two seconds after, it will exit read-only mode and return to normal. You will lose $0. 

The only situation where you can potentially lose all of your equity is if the price crashes extremely quickly and you become bankrupt before your position can be saved. This will happen in less than 1% of all liquidations.

asset 2

The difference can be huge

Let’s say you have a long position of $1,000,000.

Your liquidation price is 100.

On Wednesday, while you’re on your commute home, the price drops to 99.9.

The consequence: Your position is liquidated.

A second later, the price goes back up to 100.1.

With “total liquidation”, you would lose all of your remaining equity.

Assuming a minimum equity requirement of 0.5%, that would be 0.005*$1,000,000 = $5,000.

Net loss with “total liquidation”: $5,000.

With “partial liquidation”, you wouldn’t lose anything. Your position would simply enter read-only mode for a second and then return to normal.

Net loss with “partial liquidation”: $0.

Had the price stayed below 100 for longer, you could have lost a small amount. This is because the broker would be forced to sell off 10% of your position size. You would incur a loss, but the loss would be limited to 10% of your remaining equity, or $500.

Had the sell-off of 10% your position size not been sufficient to cover your minimum equity requirements, another 10% would simply have been sold off on top of that. 

Had the price crashed extremely quickly (so quick that the broker’s automated liquidation system couldn’t react in time), you could potentially have gone bankrupt and lost everything. This rarely happens in practice.

The difference between the two liquidation procedures can be huge.
The difference between the two liquidation procedures can be huge.

Why we care at Mushino

At Mushino, we are committed to serving the best interests of our clients.

We do not rob our clients if they get liquidated. Our clients get to keep their equity, and they get to keep their position.

They can watch the Mushino Liquidation Engine save their position from the comfort of their couch.

Everything is 100% transparent. Every order sent by the liquidation can be seen by the client — in real-time.

In some cases, no orders will need to be sent. The position simply returns to normal.

In other cases, a single order for 10% of the position size will be sent. The size of the position is simply reduced by 10%. The position then returns to normal.

This gives our clients confidence to trade with leverage. Unlike on other platforms, their loss is limited. Being liquidated doesn’t mean that they lose everything.

Liquidation is no longer a disaster. It is merely an inconvenience.

Trade with confidence. No matter the leverage.