Liquidation

Along the journey of my tutorials, I have given a brief overview of maintenance margin and liquidation. Now, let’s take a closer look at what liquidation is and why is it even necessary.

Spoiler alert: no, liquidation is not just for taking away your funds.

Like in most examples, it’s time to talk about Steve. Imagine Steve buying 10,000 XBTUSD contracts @$10,000 with 10x leverage. So it means Steve invests $1000 and borrows $9000. Unfortunately, the price falls to $8500, so Steve’s whole position is now worth $8500. Remember Steve still owes $9000 and now he has not only lost invested $1000 but an extra $500, making the total loss of 150%.

And this is why we need liquidation, it prevents us from losing more than initial margin (which in Steve’s case was $1000), while we can still earn more than initial margin. Liquidation basically limits our risk.

First of all, lets explain two terms.

Bankruptcy price is a price at which you have lost your initial margin.

Liquidation price is a price that Bitmex sets a bit higher than bankruptcy price for long and a bit lower for shorts.

If the market moves in an unfavoured direction and reaches the liquidation price, your position is taken over by the liquidation engine. It is important to note that liquidation uses a fair pricing method, which means the trigger price is mark price. It makes your position less vulnerable to market manipulations.

Now liquidation engine tries to get rid of your position choosing a strategy based on risk limit tiers. Some magic, that is not important to us happens, and liquidation is completed. An important aspect of liquidation is that Bitmex does not always earn from liquidation.

Sometimes they have to get rid of your position below (or above for shorts) bankruptcy price. On average it is profitable to them and the Bitmex's insurance fund data is publicly available.

Thus far, you have learned almost everything you need to know about trading on Bitmex, the only part missing is fees and as a little bonus for staying on the course, I will write an article about risk management as well.