Leverage and liquidation: how margin works and how to stay clear of it

Leverage lets you hold a position bigger than the money you put up, and liquidation is the exchange closing that position when your losses have used up almost all of that money. The higher the leverage, the closer the liquidation price sits to your entry: at 20x on a long it is only about 4.5% below, close enough for an ordinary wick to reach it.

This guide explains what margin is, the difference between isolated and cross margin, how the liquidation price is roughly worked out, and why leverage does not change how much you should risk on a trade. It builds on how much to risk per trade, so read that first if position sizing is new to you. If you are just starting out, the short version is in crypto trading for beginners: trade spot until you have a record of following your own rules.

What is leverage in crypto trading?

Leverage is the ratio between the size of a position and the money you put up to hold it. At 10x, $1,000 of your own money controls a $10,000 position. Most crypto leverage is offered through perpetual futures, contracts that track the price of a coin without ever expiring.

The profit or loss is worked out on the full position, not on your stake. If a $10,000 position moves 1%, that is $100 either way, whether you put up $10,000 at 1x, $1,000 at 10x or $500 at 20x. What changes is how large that $100 is compared with the money backing the trade: 1% of it at 1x, 10% at 10x, 20% at 20x.

What is margin?

Margin is the collateral the exchange holds against an open leveraged position. There are two numbers to know.

• Initial margin is what you post to open the position. It is the position size divided by the leverage: a $10,000 position at 10x needs $1,000.
• Maintenance margin is the minimum the position must keep after losses. It is set as a percentage of the position size, the maintenance margin rate. On many exchanges it starts around 0.4% to 0.5% for smaller positions and rises for very large ones.

As the trade moves against you, losses come out of the margin. When what is left falls to the maintenance level, the position is liquidated. The gap between initial and maintenance margin is your room to be wrong.

What is the difference between isolated and cross margin?

Isolated margin

With isolated margin, each position has its own fixed pot of collateral. If it is liquidated, you lose that pot and nothing else. The liquidation price is easy to find and does not move when other trades win or lose. For most people this is the clearer choice, because the worst case of each trade is visible before you enter.

Cross margin

With cross margin, the whole futures balance backs every open position. A losing trade can draw on spare balance, which pushes its liquidation price further away. The cost is that a single bad trade, or several correlated ones moving together, can drain far more than you meant to put at stake.

The rest of this guide uses isolated margin.

How is the liquidation price calculated?

For an isolated long, a rough rule is:

The logic is simple. At 20x your margin is 5% of the position, so a 5% fall would erase it. The exchange does not wait for zero: it steps in when the remaining margin reaches the maintenance level, here 0.5% of the position. So liquidation comes after a fall of about 5% − 0.5% = 4.5%. For a short the same idea runs upward: liquidation sits roughly 1 ÷ leverage above entry, less the maintenance rate. The how to short crypto guide covers that side.

Treat these numbers as estimates. Exact formulas vary by exchange, maintenance rates change with position size, and trading fees and funding payments are taken from the margin, which nudges the liquidation price closer over time. Always read the liquidation price the exchange shows you before you confirm the order.

Why doesn't leverage change how much you should risk?

Because the risk on a trade is set by two things only: the position size and the distance to the stop. The site's sizing rule is position size = (account × risk %) ÷ (entry − stop), with 1% as the default risk. Leverage does not appear in it. Once you know the size, leverage only decides how much collateral the exchange holds while the trade is open.

The order matters. First pick the stop, at the place where the trade idea is wrong (see stop-loss placement). Then size the position from it. Only then choose a leverage setting, so that the liquidation price is nowhere near the stop. Reverse the order, picking margin and leverage first, and the risk is decided by the leverage slider rather than by the stop.

What does a worked example look like?

Why must the liquidation price be well beyond the stop?

This is the key rule of using leverage at all. Your stop is the planned exit. Liquidation is an unplanned exit that usually costs more: you lose the margin, often pay an extra liquidation fee, and the fill can be poor because many positions are being closed at once. If liquidation sits between your entry and your stop, the stop is decoration.

"Well beyond" means more than a hair. A useful habit is to want the liquidation price at least as far beyond the stop as the stop is from entry, and further on volatile coins. In the 5x example above the stop is 4% away and liquidation about 19.5%, which leaves plenty of room. At 20x, with liquidation 4.5% away, no stop placed past normal structure would be safe.

If the liquidation price is too close, lower the leverage. With isolated margin that means posting more collateral for the same position, not buying more. The risk at the stop stays exactly the same.

How do wicks and liquidation cascades hit leveraged traders?

Look at the chart above. A long is entered at 100 and price dips in a routine wick to about 93 before recovering. The 20x position, with liquidation near 95.5, is closed out on the way down. The 10x position (liquidation about 90.5) and the 5x position (about 80.5) are untouched, and both are still open when price comes back.

Wicks like this are common in crypto, and they are not always random. Many traders use similar leverage and similar entries, so their liquidation prices cluster at similar levels, often just below obvious swing lows and round numbers. When price reaches a cluster, the exchange sells those longs into the market. That selling pushes price lower, which reaches the next cluster, which adds more selling. This chain is a liquidation cascade. It can turn a 2% dip into an 8% wick that recovers within the hour.

The same thing runs upward with shorts. Setups such as the previous-day sweep are built around these quick runs through obvious levels, which is a good reason to keep your own liquidation price far from them. The long lower wicks they leave are covered in how to read candlestick charts.

What does funding cost on a leveraged perpetual?

Perpetual futures charge or pay a funding rate, usually every 8 hours on many exchanges, to keep the contract price close to spot. When funding is positive, longs pay shorts. The payment is a percentage of the position size, not of your margin, so leverage makes it bigger compared with your stake.

Funding comes out of the margin on many exchanges, so on a tightly margined position it slowly drags the liquidation price closer. In busy rallies it can run many times higher than 0.01%. The funding rates explained guide covers how it works and what it says about crowding.

Common mistakes

• Choosing leverage before the stop. Picking 20x first and letting the size follow means the risk is set by a slider, not by where the trade is wrong.
• Using liquidation as the stop. Liquidation usually costs the whole margin plus fees and fills badly in fast markets. A planned stop is cheaper and more precise.
• Letting liquidation sit near the stop. Half a percent of room disappears in a single wick or a bit of slippage, so the stop never gets the chance to work.
• Using cross margin without meaning to. A losing trade can then draw on the whole balance, and several correlated longs can go down together.
• Ignoring funding on multi-day holds. Funding is charged on the full position size, so a large leveraged position held for a week can pay away a meaningful share of its expected gain.
• Adding margin to save a losing trade. Topping up collateral to push liquidation away while the stop is being ignored just makes the eventual loss bigger.

What to check

1. Where is the stop, and why there? It should sit past the structure the trade is built on, plus a 0.2 ATR buffer. If you cannot name the reason, the size that comes from it is not reliable.
2. What is the position size from the stop? Divide 1R in dollars by the distance to the stop. That is the size, whatever leverage you then choose.
3. Do you need leverage at all? If the position fits within your account on spot, leverage only frees up collateral. That can be useful, but it adds a liquidation price and funding.
4. Is the margin isolated? Check the setting before you open the trade, so the worst case is the margin you posted and nothing more.
5. Where does the exchange say liquidation is? Read the number on the order screen rather than relying on the rough formula, and confirm it is well beyond the stop, ideally by at least the stop distance again.
6. What will funding cost if you hold? Multiply the rate by the position size and by the number of intervals you expect to hold, and compare it with 1R.
7. Is there a cluster of obvious stops or liquidations nearby? If your liquidation price is just below a clear swing low or round number, that is where cascades tend to reach. Lower the leverage.

Further reading

• Leverage (finance) Wikipedia
• Margin (finance) Wikipedia
• Perpetual futures Wikipedia