What is Forced Liquidation
When forced liquidation occurs, an investor’s assets are sold for cash or cash equivalents by a brokerage to cover losses on borrowed funds. This mainly happens in margin or futures trading. It depends on the leverage and the margin requirements. Leverage is adopted by investors to increase their gains on an investment. However, although greater returns are possible, a higher leverage implies higher risks.
For example, if an investor puts down $100 as collateral and make a $1000 investment in an asset using borrowed funds, his leverage is 10x and his margin is 1:10. The $1000 investment would be made up of $100 of the investor’s personal funds and $900 of borrowed funds. If the price of the asset falls below the required margin and the investor does not add more collateral, the investor’s collateral would be liquidated to recover the losses.