Negative balance protection means that you can't lose more money than you did deposit. It is important to know that some brokers offer negative balance protection, while some brokers don't. There are still brokers that require you to deposit more money when you have a negative balance. Here at Short Selling, we help you find the best brokers with negative balance protection.
How did it start?
If you don't do so, the broker can come after you and collect the money you owe for it. The history of negative balance protection is connected with the Swiss franc crisis in 2011. After the Swiss franc crisis when the Swiss National Bank (SNB) stopped holding its currency against the EUR at a fixed currency rate the negative balance protection became more important. The Swiss franc rapidly strengthened against the EUR, and a lot of traders shorting the franc ended up with huge negative balances. They basically lost more than they had 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. Therefore, Short Selling always recommends a serious broker like Skilling to avoid any negative balance, ever. Regardless what happens in the market.
In the chart above we can see what did happen in 2011 when the Swiss National Bank (SNB) stopped holding its currency against the EUR at a fixed currency rate. The CHF rapidly advanced against the EUR, and a lot of traders shorting the CHF basically lost more than they had on their account.
Thanks to ESMA regulation, the brokers that offer trading with leverage are obliged to apply for negative balance protection on a per-account basis. The European Securities and Markets Authority (ESMA) has implemented a range of measures intended to protect retail clients who are trading leveraged products, such as CFD’s:
- Negative balance protection on a “per account” basis
- Maximum leverage limits on the opening of a position by a retail client ranging from 30:1 down to 2:1
- A margin closeout rule on a “per account” basis (at 50% of the minimum required margin)
- A restriction on the incentives offered to trade CFDs
Forex and CFD markets are extremely volatile and if you hold a leveraged position without negative balance protection you could have to pay your debt back to your broker. When you set negative balance protection it is better and smarter for your trading account. Negative balance protection ensures that you do not lose more than the balance on your account – even if the market moves quickly or gaps which is very often in the financial markets.
The example of negative balance protection
The example of negative balance protection – If you deposit $5,000 to your account and you buy a share with 10:1 leverage. In this case, you will have a position of $50,000. If there is a negative market turbulence and your share price drops 7%, you will suffer a 70% loss due to your leverage. This is $35,000 loss in US dollars. This loss will eat your $10,000 deposited money and a further $25,000 which you will owe to the broker. If you do this transaction at a broker that provides negative balance protection, your loss can't be bigger than the deposited $10,000. In other words, negative balance protection guarantees that you will not lose more than your deposit is even if your account moves into negative as a result of your trading activity. In today’s highly volatile turbulent trading environment, negative balance protection helps traders to enjoy a tension-free trading experience without having to worry about incurring debt. That's why we recommend going with international brokers with an amazing plattform, such as Capital (review). Let's try Capital now!
Brokers and Negative Balance Protection
Brokers practice negative balance protection in order to protect their clients even if their account moves into negative as a result of their trading activity. Retail brokers use different formulas to implement the policy for negative balance protection. In other words, brokers must have control over the trading accounts to implement the protection. For example, some brokers only reimburse the negative amount once all positions held on an account have settled, and then they reset the account to zero or set a margin closeout rule of 50%. Negative balance protection is designed as a backstop in case margin closeout doesn’t trigger, or triggers late due to a sudden price movement.
When you are choosing a broker, always check history and reviews to make sure their performance is consistent. Checking the reviews is something you should always do. You can find lots of useful information and reviews on the internet. The Internet also makes it very easy for people to post their experiences and useful information. Forums are a very good place to find objective third-party reviews of all the platforms and any broker. It can be difficult to choose the best broker, here are a few other key points that are very important:
- Regulation – every country has its own regulatory body and you should open an account with regulated firms
- Account Types – choose a Broker that offers customizability, competitive spreads and easy deposits/withdrawals. A good broker should always allow you to deposit funds and withdraw your earnings whenever you feel like it.
- Choose a Broker with good customer service. Give a call or message to the customer service center and check their availability and find out the representative’s ability to answer questions. Brokers should be there helping with accounts and technical support when you need them the most.
- Broker with a platform that’s easy to use
It is important to say that the retail brokers are also facing risks due to the negative balance protection clause. Some brokers are tending to hold a single omnibus account with their liquidity provider, where their client exposures are netted. These brokers are much more at risk in affording negative balance protection. On the other side, some brokers do not offset their risk but instead take the other side of their client positions. So, these brokers do not have a very big risk in affording negative balance protection. Liquidity providers cannot realistically offer negative balance protection to retail brokers and it’s the broker's responsibility to choose the right liquidity provider that offers the best execution and complies with ESMA (the European Securities and Markets Authority). We can conclude that retail brokers should be aware of the misleading promises emanating from various liquidity providers because they can get into trouble. Don't get in trouble. Go with a great long and shorting broker such as AvaTrade today!