Before jumping into Forex trading, most of us may understand that it’s a promising market but also contains many hidden risks. Have you ever seen an investor that lost a lot of money and went into debt, when the markets moved against them? To help stop this from happening, negative balance protection was born.
What is Negative Balance Protection?
As its name indicated, negative balance protection is a tool ensuring that a trader who is in a losing position cannot get into below-zero balance (negative balance). You might not see the term “negative balance protection” mentioned by some brokers, but I’m pretty sure that you have already heard about “margin call”. Yes, it’s exactly the mentioned “negative balance protection”.
When your account balance drops to zero, it will close your open losing position. In other words, negative balance protection means that you can’t lose more than the amount you have deposited.
Why do we need Negative Balance Protection?
Forex trading is always an attractive but risky investment channel, especially with new traders. Ironically, the same beginners usually take advantage of leverage to magnify the potential income, without realising that it also raises their possible loss. This loss, however, can wipe out all their small starting balance.
Let’s see an example:
If a new trader deposits £1,000 with the chosen leverage of 1:100. He decides to buy a standard lot of EUR/USD, and with leverage this is an actual position of £100,000. Unfortunately, there is an economic crisis at a large country in the Eurozone, causing the rate to sharply drop. The exchange rate falls by 0.12%. But due to the leverage, the unfortunate trader suffers a magnified loss of 0.12% x 100 = 1.2% or £1.200 in money. That loss not only consumes all his £1,000 deposit, but also leaves him a debt of £200.
The maths may be a little complicated, but by this example, you can understand that a negative balance is totally possible and it is unexpected by both traders and brokers. For brokers, debt collection is feasible with local residents, but it may take a lot of time and procedures with traders from other countries, since the forex market is international. Negative balance protection can save you from this debt.
How can Negative Balance Protection attract traders?
Volatility is like a high wave that every surfer wants to ride, even though it is also dangerous; in forex trading, high volatility brings traders a big opportunity to generate profit but it can also erase all their money in the blink of an eye. Therefore, negative balance protection can help trader take advantage of volatility without worry of owing the broker if their trades fail.
You might notice that not every broker offers negative balance protection. Some brokers may offer drawdown bonuses (which allow you to lock your open positions, even when your own balance reaches zero) as remediation to traders’ losses, to help them continue their trades. Other brokers use negative balance protection as a trustworthy advertisement to persuade new traders to use their service.
Remember that there are brokers who simply offer negative balance protection, and brokers who guarantee it. Brokers also participate in the market and they can also suffer losses; therefore, only brokers who have good standing with stable and sufficient capital can assure your account against the market’s fluctuation.