Understanding the Liquidation Risk: A Complete Guide from Margin Calls to Forced Liquidation

Have you heard the story of an investor losing $20 billion in just two days? In March 2021, hedge fund manager Bill Hwang became the fastest person in Wall Street history to lose money, shocking the entire financial industry. His story isn’t just about investment losses but also triggered by a chain reaction caused by a phenomenon called “liquidation” or “margin call.” What does this mean? Why does it cause such devastating impacts on investors? Let’s explore in depth.

How does liquidation happen? Understanding financing and forced liquidation mechanisms

Liquidation is a key concept in stock and futures trading. Essentially, it occurs when an investor’s leveraged position is forcibly closed by the broker due to a decline in stock price.

To understand liquidation, first grasp how margin trading works. Suppose you’re confident in a stock but lack sufficient funds to buy enough shares. You can apply for margin financing—meaning you put in part of the money, and the broker loans you the rest to complete the purchase. For example, if Apple stock is $150 per share and you have only $50, the broker can lend you $100, allowing you to buy one share.

This method seems advantageous. If Apple then rises to $160, you sell, repay the broker $100 plus $0.5 interest, and keep $59.5 profit—about a 19% return, far above Apple’s 6.7% increase. But if the stock drops to $78, the situation changes dramatically.

At this point, the broker becomes uneasy because the $100 loan now faces potential loss. When the stock price falls to a certain level, the broker will require the investor to “top up the margin”—that is, add more funds to maintain sufficient collateral. If you cannot meet the margin call within the specified time, the broker will directly sell your shares—this forced sale is called “liquidation” or “margin call liquidation.”

For example, in Taiwan stocks, margin requirements are typically 40% investor contribution and 60% broker loan. When the stock price is $100, the maintenance margin is 167% (calculated as 100 ÷ 60). If the price drops below the warning level of 130% maintenance margin—meaning the stock price hits $78—the broker will initiate a “margin call.” Investors must add funds within the deadline; otherwise, the broker can execute forced liquidation.

Chain reaction of liquidation: Why do stock prices keep falling?

The most frightening aspect of liquidation isn’t just individual cases but the domino effect and market turbulence it causes.

Ordinary investors tend to hesitate and sell when prices fall. But brokers have no such sentiment—they want to recover their lent funds as quickly as possible. During forced liquidation, brokers usually don’t negotiate for higher sale prices; they sell at any available price to unload the position. This means that when a stock triggers margin calls due to sharp declines, it may be sold at prices far below market value, causing the stock to oversell.

This overselling can trigger panic among other leveraged investors, leading to more margin calls. As more forced sales flood the market, stock prices continue to plummet, creating a vicious cycle. For long positions, this is a warning sign; for short sellers, it might be an opportunity to profit.

Additionally, when large volumes of margin stocks are forcibly sold, these stocks flow into retail investors’ hands. Retail investors tend to be short-sighted, trading frequently on minor fluctuations. As a result, big funds lose interest, and the stock may enter a downward spiral until a major positive news event attracts institutional investors again.

Beware of chaotic chips: Risks after liquidation

If liquidation causes stock prices to fall, why are stocks more dangerous after liquidation?

The answer lies in the change of shareholding structure. Under normal circumstances, a company’s stock ownership is held by internal management and long-term institutional investors (like pension funds, insurance companies), which provide stability. But after liquidation, the stocks flood into retail hands, making the shareholding structure chaotic and unstable.

Retail holders may sell at any sign of trouble, removing support for the stock. Large institutional investors tend to exit or stay on the sidelines. As a result, the stock continues to decline until a new major positive catalyst appears. Many experts advise avoiding stocks that have recently undergone liquidation, as the short-term risk of further decline remains high.

Bill Hwang’s warning: The truth behind $20 billion evaporating in 2 days

Returning to the story of Bill Hwang. He was an experienced hedge fund manager who used carefully selected stocks combined with heavy leverage to amplify returns. His aggressive strategy brought him huge success—within ten years, his assets grew from $220 million to $20 billion, making him a prominent figure on Wall Street.

But high leverage is most vulnerable to black swan events. In March 2021, amid significant market volatility, Hwang’s large holdings faced severe turbulence. Several of his margin brokers, aiming to mitigate risk, began executing forced liquidations of his positions.

The severity lay in the massive size of Hwang’s holdings. When ordinary investors face margin calls, they might sell a few thousand shares; Hwang was selling millions. The market lacked enough buy orders to absorb such huge sell-offs, causing prices to gap down. As his stocks were heavily dumped, other investors holding similar stocks with different leverage ratios also triggered margin calls.

Worse, to maintain overall leverage ratios, even his better-performing stocks were forcibly sold. This intensified market panic, causing nearly all his holdings to plummet within a short period. Stocks like Baidu and other Chinese tech giants also suffered heavy declines. In just two trading days, Hwang lost about $20 billion, setting a record for the fastest loss in modern financial history.

Advanced margin strategies: how to profit with leverage instead of getting wiped out

While margin trading appears risky, skillful use of leverage can significantly improve capital efficiency. The key is understanding risks and establishing clear operational principles.

Gradual positioning rather than all-in bets. If you are optimistic about a company but have limited funds, instead of buying all at once, use margin to buy in stages. As the stock rises, you enjoy leverage gains; if it falls, you can add more funds gradually, lowering your average cost and preparing for a rebound.

Choose highly liquid stocks. Hwang’s story teaches an important lesson: never use margin to buy small-cap or illiquid stocks. When large players need to unwind positions, these stocks face extreme volatility. Conversely, giants like Microsoft, Apple, Amazon with high market cap and liquidity won’t face liquidity crises even during heavy selling.

Calculate returns and costs precisely. Margin involves paying interest to brokers, so the expected return on the stock must be clearly higher than the financing cost. If a stock pays 3% dividends annually and the margin interest is also around 3%, margin buying may not be worthwhile and could increase risk.

Use support and resistance levels wisely. Stocks often have specific support and resistance levels. If you buy on margin and the stock hits a resistance level but can’t break through, it may consolidate longer. During this period, interest payments erode profits. A smarter approach is to take profits when resistance can’t be broken or cut losses if the stock falls below support, avoiding further losses.

Set clear stop-loss and take-profit points. Disciplined trading is fundamental for long-term success. Regardless of market volatility, adhere to pre-set rules rather than making impulsive decisions driven by fear or greed.

Conclusion: leverage is a double-edged sword

Leverage is like a double-edged sword. When used effectively, it can amplify gains and accelerate wealth accumulation; but it also magnifies losses at the same speed. Hwang’s rapid fall from $20 billion to nearly zero, and the chain reaction of margin calls causing stock prices to crash, are profound lessons on leverage’s power.

Margin trading is a high-risk strategy that offers opportunities and dangers. If you choose to enter this arena, do thorough research beforehand—understand how margin works, what triggers liquidation, and the importance of market liquidity. Only then can you stand firm amid leverage waves, rather than becoming the next victim of liquidation risks.

Remember: the most expensive lessons often come from ignoring risks. Better to be cautious beforehand than regret afterward.