What is negative balance protection and why is it good for you?
4 min read
by G. Gligorijevic
Negative balance protection signifies that you will not lose more than your deposited money. Or to put it simply, you won’t owe money to your broker. Sounds great, indeed. You will not end up with a cash debt on your account.
At first glance, this looks like a great thing. For example in spread betting, that lets traders take leveraged short-term bets on stocks could end in tremendous losses.
Here is one example.
Assume you put $10,000 to your account and want to buy stock. Let’s say the leverage is 5:1 which would provide you a position of $50,000. But, the market is really volatile those days and the price of your stock drops, for example, 8%. Remember, your leverage is 5:1, so this drop would make you a loss of 40%. It is $20,000 of lost. This lost would destroy your deposit of $10,000 and you have to pay back to your broker what you owe. Yes, this is an unpleasant situation but if you are trading with a broker who lets you negative balance protection, your loss would be exactly the amount you deposited, $10,000. Nothing more, nothing less.
It is a great thing for traders.
Negative balance protection is a proposal that brokers practice in order to protect their customers. This method guarantees that traders will not lose more than their deposit is if their account moves into negative as a result of their trading activity. This is a great reason to choose the broker that provides it. You will not owe the money to your broker if you made the wrong trading choice.
Yes, the brokers always have a margin call to protect. The truth is that this option isn’t the best choice when the market’s shift quickly and the stock prices are in high-speed movements. If the price moves too fast and moves beyond your margin call out level you may lose more than it is expected.
Negative balance protection in Forex
It protects your account balance never to falls under zero. How is possible for your Forex trading account to go under zero?
Don”t be worried. Your broker has protection, in the first place it is margin call. But, the same occurs as it is with stocks. When some incredible drastic move happens in the currency markets, your broker may not be able to close your trade immediately. Also, your stop-loss order will not be executed due to the high speed of the market movement.
Therefore, the price may run beyond your stop loss or margin call close out level. That may cause a larger loss that exceeds the size of your account balance. So, you would have a negative balance.
This is where negative balance protection comes to the scene. The broker can overlook or forgive your negative balance and lets your account to begin from zero again.
Why traders need this?
Forex and CFD markets are volatile. That makes traders unprotected in sudden price movements and gaps. When extreme price movements happen in open trade, this may have an important influence on the value of your open positions. It is particularly dangerous when your position is highly leveraged.
If you hold a leveraged long position, you would lose more than your initial deposit. And as I said before, this would put you in a position where you would have to pay your debt back to your broker.
Negative balance protection resets your account balances to zero.
Is there anything bad?
In short, yes.
When you enter the market you are dealing with some unresponsible people who don’t pay attention to the risk involved because their goal is to beat the market. Sic!
When you set negative balance protection heaven isn’t the limit. This safety net wouldn’t let you take additional risks just because you have the belief that you can make easy money. Stay in the safe zone, it is smarter and better for your trading account.
Also, if you put negative balance protection, you have to pay increased margin rates.
The history of negative balance protection
It grew more prominent after the Swiss franc crisis in 2011. That was when the Swiss National Bank (SNB) closed holding its currency against the EUR at a fixed currency rate. The Swiss franc rapidly soared against the EUR. The consequence was that numerous traders shorting the franc ended up with enormous negative balances losing more than they had deposited on their account.
The Swiss market had great losses and many traders ended up with the fear that their brokers would ask to get paid to cover their losses.
The brokers that provide the leverage are obliged to apply for negative balance protection on a per-account basis, thanks to ESMA regulation for the EU.