Why Do Forced Liquidations Occur During High Volatility in Crypto?

Cryptocurrency markets are known for their sharp price fluctuations, rapid reversals of trends, and emotionally charged trading conditions. It is during these events that one trend tends to prominently feature on data graphics and news headlines—forced liquidations. High liquidation values are commonly seen during market collapses, rallies, or rapid peaks, prompting an important question: why do forced liquidations happen when volatility is high?

Forced liquidations are not necessarily inadvertent or malicious in nature. They are intrinsic to the risk profile of a leveraged trade in the world of cryptos. When prices change rapidly in the cryptos, whether it is a rise or a fall, a situation emerges in which leveraged positions can become susceptible to forced liquidations, especially if traders do not have enough margin in their accounts to deal with such price fluctuations.

This article aims at analyzing how and why forced liquidations take place, and how volatility brings an astronomical number of them, alongside some of the underlying psychological, market, and structural factors that come into play. The objective is to better understand what is taking place during such turbulent times in crypto markets.

What Are Forced Liquidations in Crypto?

Force liquidation refers to a situation where a cryptocurrency exchange suddenly closes a trader’s margined position because the trader is no longer able to fulfill a minimum margin requirement.

In Leveraged Trading:

• Clients borrow money to amplify risk

• They deposit collateral (margin)

• Losses narrow this gap

• If the margin is below the level of maintenance, liquidation is initiated

This allows the exchange to close out the trade to ensure that it has enough funds to repay the borrowed money.

Most significantly, the compulsories are rule-based and exchange-controlled and automatic.

Volatility: Understanding Cryptocurrency Trading

"Volatility" refers to the rate of change and amplitude of asset prices over time. The crypto markets are more volatile than a lot of other markets because of a variety of reasons, which include:

• Overall liquidity will decrease

• High speculative demand

• Continuous trading.

• Sensitivity to news and sentiment

• Excessive use of leverage

The higher the volatility, the faster and more erratic the prices will become. Such a scenario provides a conducive environment for a greater number of compelled liquidations to take place in the market.

Why Do Forced Liquidations Occur During Periods of High Volatility?

1. Price Moves Become Too Fast for Margin Buffers

In volatile markets, prices can change several percentage points in a matter of seconds or minutes. A leveraged position depends on its margin for a buffer against losses, but that buffer is easily eaten into when prices move hard.

For example:

• A trader using 10x leverage has only a tiny margin for error.

• A sudden 5–10% adverse move can wipe out their collateral

• Liquidation occurs before it is humanly possible to intervene

High volatility compresses reaction time and increases margin stress.

2. Leverage Amplifies Volatility

Leverage does not create volatility, but it magnifies it.

When there is more volatility,

• Small changes in price create big swings in profits or losses.

• Margin balances fluctuate rapidly.

• Liquidation prices are reached much quicker

This is why liquidation spikes often appear during sudden market movements, even if the general trend does not change afterwards.

3. Slippage & Order Book Gaps Increase Losses

During periods of volatility:

• Liquidity can temporarily disappear

• Order books thin out

• Execution of market orders at prices worse than expected.

This slippage increases realized losses and can push positions into liquidation even if the theoretical price level was not reached under normal conditions.

4. Liquidation Cascades and Squeeze Dynamics

Forced liquidations can actively amplify volatility through cascade effects.

When large leveraged positions are liquidated:

• Exchanges execute market orders

• Prices move further in the same direction

• Additional positions hit liquidation thresholds

This mechanism often results in a “Long Squeeze”, where falling prices trigger liquidations of over-leveraged long positions, accelerating downside momentum.

Conversely, during sudden upward price spikes, heavily leveraged short positions may be forced to close, leading to a “Short Squeeze”, where rapid buying pressure pushes prices even higher.

5. Extreme Market Sentiment Encourages Risky Positioning

Periods of high volatility often align with emotional extremes in market sentiment. Indicators like the crypto fear and greed index help illustrate whether markets are dominated by panic or excessive optimism.

• Extreme greed encourages over-leveraging, often preceding long squeeze scenarios

• Extreme fear leads to panic exits and abrupt reversals, increasing liquidation risk

• Both conditions amplify forced liquidations as traders react impulsively

Both conditions increase the probability of forced liquidations as traders take on more risk or react impulsively.

The Role of Leverage in Liquidation Risk

Leverage determines how sensitive a position is to price movement.

Relationship Between Leverage and Liquidation Risk