What is auto-deleveraging (ADL)?

A last-resort mechanism in which a derivatives exchange force-closes profitable traders' positions to cover losses it cannot otherwise absorb.

When a liquidation fills worse than the bankruptcy price and the insurance fund runs dry, someone has to take the other side, so the engine ranks opposing positions by profit and leverage and closes them from the top of the queue. Being auto-deleveraged means a winning trade is closed without your consent at the bankruptcy price.

Exchanges publish an ADL indicator on each position showing how near the front of the queue you sit. Most traders never look at it until the day it matters, which is precisely the day the market is moving fastest.

How it works

A leveraged position is liquidated when its margin no longer covers its losses. The exchange takes over the position and tries to close it in the market at or better than the bankruptcy price, the price at which margin is exactly exhausted.

In a fast market the fill can be worse than that. The shortfall is paid from the insurance fund, which exists to absorb exactly this.

If the fund cannot cover the shortfall, the exchange cannot simply print the difference, and it will not let a position sit unmatched. So it closes positions on the other side. Whose position gets closed is decided by a ranking that combines unrealized profit percentage and effective leverage, so the most profitable and most levered opposing traders go first.

Closure happens at the bankruptcy price of the liquidated trader, not at the market price. A trader deep in profit can therefore have that profit closed out at a price well away from where the market is trading.

The alternative used by some venues is a socialized loss, spreading the shortfall across all profitable traders instead of fully closing a few. Both are ways of forcing a matched book when the buffer fails.

Example

Illustrative: you are short and up 60% on a position, sitting in the top band of the ADL queue. A violent upward move liquidates a large long. The forced buying fills far above the bankruptcy price and the insurance fund is exhausted. The engine closes your short at the long's bankruptcy price. You keep the profit realized to that point but lose the position entirely, and if the market then falls back, you are no longer in it.

Why it matters when you buy

If you only buy spot, this never touches you, and that is the point worth taking away: leveraged products carry a class of risk that has nothing to do with your own analysis being right. Even a correct, profitable position can be closed by the exchange's risk engine. Spot buying at the exchange directory has no equivalent mechanism.

Related terms

• insurance fund — the buffer that is exhausted first
• liquidation — the forced close that starts the chain
• perpetuals — where ADL is most commonly seen
• leverage — what pushes you up the ADL queue
• mark price — the reference used to trigger liquidations
• negative balance protection — the retail protection some venues offer

Questions

Can I opt out of auto-deleveraging?

No. It is part of the contract specification on venues that use it. The only control you have is reducing leverage and unrealized profit concentration, which moves you down the queue.

How do I know my ADL risk?

Most derivatives venues show an indicator, usually a row of lights, on each open position. More lights means closer to the front of the queue. Check it before size, not after.

Does this happen often?

Rarely, and almost always during extreme moves when liquidity vanishes. That rarity is why traders discover it during the worst conditions rather than in normal markets.