What is a Liquidation Level
In the foreign exchange marketplace, liquidation level is the predetermined level at which an automatically-triggered liquidation process will begin. This value is the specific amount of funds in a trader's margin account below which the liquidation of the trader's positions is triggered and executed at the best available exchange rate at the time. Another name for liquidation level is liquidation margin.
These types of forced sales of positions to meet margin requirements, do not require customer approval.
BREAKING DOWN Liquidation Level
The expression of the liquidation level is a percentage value of the assets in a trader's margin account. If a forex trader's positions go against them, their account will eventually reach the liquidation level, unless the trader contributes further to top-off their funding.
Most forex traders will buy on margin which is the act of borrowing money to purchase securities. The practice includes acquiring securities where the buyer pays only a percentage of the value and borrows the rest from the bank or broker. The broker acts as a lender and the securities in the trader's account act as collateral. Based on one's creditworthiness and other factors, the broker will set the minimum or initial margin and the maintenance margin which must exist in the account before the trader can begin buying on margin. Maintenance margin refers to the minimum amount of money that must be in the account before the broker forces the investor to deposit more money.
With cash accounts, a broker does not have the same ability to liquidate unless it is due to an external factor like a personal bankruptcy. A margin account, on the other hand, allows investors to borrow up to 50% of the purchase price of the security. However, the exact amount of the margin varies depending on the security. A typical requirement of a margin account is to maintain at least 25% equity, or your own money, of the total market value at any given point.
Liquidation Level as a Protective Tool
Liquidation level is a failsafe, or security feature developed to protect traders and the dealers who represent them from incurring significant losses beyond a specified point. When a forex trader's account funding reaches the liquidation level, all positions held by the trader will automatically close at the best available rate. The exact level for this action to initiate will vary by broker or dealer where the trader holds their account.
Forex trading makes heavy use of leverage. The initial upfront investment, known as a margin, is required to gain access to the foreign currency market. When prices shift, margin calls force the investor to invest additional money. In cases where there are many price adjustments in a short period, it will cause a rapid succession of margin calls, which presents the possibility of significant losses within a trading account.
When a dealer is handling trading activity on behalf of a trader, the dealer is assuming the risk of these potential losses. Therefore, the forex dealer holding an account for a trader takes on the likelihood that the trader's positions will lose money. Another risk to the dealer is that the trader will be unable to repay the borrowed funds used to make the forex trades. As such, a named liquidation level, which the trader agrees to when opening their account, will fix the minimum margin requirement. This margin requirement, expressed as a percentage, is what the forex dealer will tolerate before automatically liquidating the trader's assets to avoid the possibility of default. This action serves as a protective measure which gives the dealer some assurance that they have limited vulnerability to loss.