Leverage and liquidation

Lesson three: leverage and liquidation. In lesson one, you saw that futures let you control a bigger position than the money you put up. That's leverage, and it's also how a small move can empty an account. By the end of this lesson, you'll know where your liquidation price sits, and how close it is.

Say you have $1,000 to trade with. On spot, that buys $1,000 of Bitcoin. With futures, you post that $1,000 as margin. Margin is the money you put up to open a position. At five times leverage, your $1,000 controls a $5,000 position. At ten times, $10,000. At fifty times, $50,000. Notice what stays the same. Your margin is still $1,000. Only the position grows. Margin equals position size, divided by leverage.

Here's the catch. Your profit and loss are worked out on the whole position, not on your margin. Say Bitcoin falls two percent. On spot, your $1,000 loses $20. At ten times, two percent of $10,000 is $200. That's a fifth of your margin, gone. At fifty times, two percent of $50,000 is $1,000. That's all of it. The market made the same small move each time. Your leverage decided how much of your margin it took. It works the same way when the price rises, which is why leverage is so tempting.

So what happens when losses eat through your margin? In this course, we assume isolated margin, where the money you post for a trade is the only money backing it. When that money is nearly used up, the exchange closes the position itself. That forced close is called a liquidation, and the price where it happens is your liquidation price. Here's an example. You go long Bitcoin at $80,000, with $1,000 of margin, at ten times leverage. That puts liquidation roughly ten percent lower, around $72,000. If the price touches it, the position is closed, and your $1,000 is gone. Even if Bitcoin turns around a minute later, you're no longer in the trade.

So how close is your liquidation price? There's a simple rule of thumb. Divide one hundred by your leverage. The answer is roughly how far, in percent, the price has to move against you before you're liquidated. At five times, that's roughly twenty percent. At ten times, roughly ten. At twenty times, roughly five. At fifty times, roughly two. And at a hundred times, less than one percent. In practice, it's always a little closer. The exchange steps in while a small slice of your margin is still left, called maintenance margin, and fees come out too.

Now put that next to a normal day. Bitcoin often moves two or three percent in a day, sometimes in an hour. Watch two traders go long at the same price. One uses ten times leverage, the other fifty. The price dips three percent, then climbs and finishes the day higher. Both were right about the direction. The ten times trader is still in the trade. The fifty times trader was liquidated in the dip, and missed the rise. With high leverage, you don't need a crash to lose your whole margin. An ordinary wobble is enough.

That's why liquidation should never be your exit plan. A stop loss is the price where you decide your idea was wrong, and you get out with a small, planned loss. Liquidation is the exchange taking everything you posted. Your stop should always sit well before your liquidation price, so it gets hit first. Every setup in Bentley's public market report comes with a stop, placed where that setup's idea would be wrong. In lesson five, you'll see why the stop decides your position size, never the leverage. Until then, try the liquidation calculator on this lesson's page at five, ten and fifty times. And for now, any trade you place stays on paper.

Let's recap. Leverage makes your position bigger, not your money. Margin is position size divided by leverage. Every move is multiplied: two percent at ten times is a fifth of your margin. Divide one hundred by your leverage to find roughly how far away liquidation is, in percent. And your stop always comes before your liquidation price. In the next lesson: funding, open interest and the crowd. And remember, this course is education only, not financial advice.