A negative balance is a protection offered by some brokers in order to attract more clients and traders. This financial protection provides a safety net for traders and keeps their investments safe, should the market go against their bet. This essentially means, if you bet some amount but lose it, you don’t have to pay your broker for the loss, if negative balance protection is enabled.
Leverage and Protective “Brakes”
Yet, one thing must be kept in mind – some brokers offer a 100:1 leverage which is within the norms. Other brokers go tenfold beyond that and offer 1000:1. This puts the traders at risk, and may also lead the brokers into financial suicide. We advise that you get yourself acquainted with your preferred broker’s policies so that you avoid agreeing to any such abnormal leverage.
History shows cases when even negative balance protection didn’t work. One such recent event is the “Black Thursday” when the Swiss National bank removed the cap on the Euro currency, which eventually had led to a negative balance in traders’ accounts.
Some brokers decided to track down its clients to ask for payments on the brokers’ losses. This resulted in massive financial losses on both clients’ and companies’ sides. The problem is always the high leverage, which may quickly bring your account down, rendering you unable to pay in case of negative balance. It’s true that high leverage can also earn you huge amounts of money in very short time. Yet it is still a risk we do not recommend you take.
So, how can you know when the negative balance protection is working for your account?
As we mentioned, make sure you familiarize yourself with your broker’s policy. Some brokers are committed to never let any of its traders’ accounts to go into negative territory. This is achieved by using protective “brakes” or tools, like Margin Call and Stop Loss. However, bear in mind that in some rare occasions, these tools don’t work in case of lack of liquidity or if the market is volatile at that moment.
Pros and Cons of Negative Balance Protection
Let us sum up the pros and cons which the negative balance protection has for you.
- Pros – Definitely a huge positive is that the negative balance protection will save you from going into a negative balance, by using Margin Call or Stop Loss. Without such tools, the protection may not be triggered and you may end up indebted to the broker and owe them money. Another strong support for this type of protection is that you can potentially opt for high leverage, although keep in mind that it holds a very high risk of loss. With high leverage, if Margin Call/Stop Loss are not triggered on time, you can potentially end up heavily indebted to your broker.
- Cons – Some brokers may decide not to honor the client’s request for a stop loss. This may lead traders into tremendous debt. In turn, the brokerages will track down its indebted clients and request the money to be paid. You can’t count on the broker to just erase the negative data from their system (although some brokers do this) and forget about you. Always ensure that your preferred brokerage offers negative balance protection. You can also ask them explicitly.
Again, in events like the one in January 2015, when the CHF/EUR currency exchange fell more than 40%, the protection brakes like stop loss and margin call did not get triggered on time. This led to many deficits in clients’ accounts. At a moment like this, it is up to the broker to decide whether to erase the negative data for its traders, or not, regardless of their policy.