What is 'Liquidation Level'

Liquidation level is the predetermined level at which an automatically-triggered liquidation process will be set into motion. This commonly comes into play in situations involving the foreign exchange market, also known as the forex market.

In forex trading, this represents the specific value of a trader's account below which the liquidation of the trader's positions is triggered and executed at the best available exchange rate at the time. The liquidation level is expressed as a percentage value of assets. If a forex trader's positions go against them, their account will eventually reach the liquidation level, unless the trader contributes further margin to top up their account.

BREAKING DOWN 'Liquidation Level'

Liquidation level can be seen as a sort of failsafe, a security feature that can help protect traders and the dealers who represent them, from incurring significant losses beyond a point at which they can tolerate.

Liquidation Level as a protective tool

Since the ultimate goal in forex trading, as with trading involving stocks, is to realize a net profit. In simple terms, this is done by adhering to the fundamental strategy of buying low and selling high. It is a process that relies heavily on good timing, a skilled strategy and a certain amount of luck. There is of course some element of risk involved, although there are steps traders can take to try and mitigate or minimize those risks.

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. Many price adjustments in a short period of time mean a rapid succession of margin calls, which presents the possibility of significant losses.

When a dealer is handling this 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 risk that the trader's positions will lose money and that the trader will be unable to repay the borrowed funds used to make the forex trades. As such, a specified liquidation level, which the trader agrees to when opening their account, fixes the minimum margin expressed as a percentage that the forex dealer will tolerate before automatically liquidating the trader's assets to avoid the possibility of default. This serves as a protective measure that gives the trader some assurance that they have limited vulnerability to loss.

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