The forex market will always be unpredictable. Traders can take measures to avoid major losses, such as using stop losses. Forex brokers can also take measures to help their traders avoid big losses, such as providing negative balance protection.
What is Negative Balance Protection?
Negative balance protection is when brokers take steps to prevent a trader’s balance from falling below zero. It prevents traders from owing them money.
In January 2015, the Swiss National Bank made an announcement that it would remove the fixed exchange rate between the Swiss Franc (CHF) and the Euro (EUR). This was an unexpected move that resulted in a sudden drop in EUR/CHF, catching many traders unaware. As a result, many traders had negative balances, and many brokers went out of business.
The crisis in January 2015 brought about the need for negative balance protection. Financial regulators came up with regulations to protect traders against such risks. For example, the Financial Conduct Authority (FCA) of the United Kingdom came up with a guideline that if brokerage firms were not going to offer negative balance protection or stop losses, then they should cover their risks using their own money. These regulations have transferred risk from the traders to the brokers.
How Does Negative Balance Protection Work?
To mitigate the risk, forex brokers have set up margin calls to alert traders in case of a potential negative balance. A margin call occurs when a broker requires a trader to deposit additional money into the account, if the account balance has decreased below a certain point.
Forex brokers usually set the margin calls as percentages. For example, if the margin decreases to 30%, the broker may alert the trader to take appropriate action. The trader may either close their losing trades or add more money to increase their margin on the trade. If the trader fails to take any action, the broker will close the trades on their behalf. This prevents a negative balance.
Let’s see how negative balance protection works in practice. Say you add $1,000 to your forex account and then enter a CFD trade with a 5:1 leverage. In this scenario, your position will be worth $5,000. If there is a sudden period of market volatility and your position suddenly falls by 25%, then you will lose $1,250. This means your $1,000 balance won’t cover your total losses and that you will owe your forex broker $250 – if they didn’t provide negative balance protection. However, if you perform the same transaction with a forex broker with negative balance protection, then your loss cannot exceed the deposited $1,000 amount, and if your position falls by 25% then your balance will be $0.
What Can You Do To Protect Against Negative Balance?
To protect yourself against the risk of negative balance you need to:
- Set up a stop-loss. You need to decide when to exit a trade. This will help you avoid big losses during periods of unexpected market volatility.
- Use Correct Leverage. You need to be careful when using leverage. Thai is because high leverage increases the potential for big losses.
- Volume/Lot-size. You should take into account how much risk you can tolerate and choose your lot size accordingly.
Why Is Negative Balance Protection Important?
Forex trading can be very risky. The markets can be unpredictable and even the most experienced traders experience losses from time to time. Margin calls are there to help traders manage their account balance and respond to sudden market movements. And negative balance protection measures are there to help traders avoid major losses and potential debts.
Do All Forex Brokers Offer Negative Balance Protection?
Most reputable forex brokers will offer negative balance protection, particularly in Europe. This is because of local regulatory requirements.
Client fund safety has always been a concern, with regulators doing their best to ensure traders are treated fairly. The European Securities and Market Authority (ESMA) is an excellent example of this. In 2018, the regulatory body announced a new regulation on forex, CFDs and binary options, which included negative balance protection on a per-account basis. Thanks to this regulation, all EU forex brokers now offer their traders the help they need to avoid negative balances.
That said, not all forex brokers offer negative balance protection. For this reason, we strongly advise checking what client fund protection measures your forex broker has before opening an account.
Which Forex Brokers Offer The Best Service?
There are so many to choose from! If you’re looking for a forex broker with negative balance protection and good client fund safety, then we recommend you check out HotForex, FXPrimus, or Pepperstone.
Final Thoughts
Negative balance protection has proven to be very important in he;ping forex traders to mitigate risk. Regulation has also proven very effective in ensuring that forex brokers help their traders avoid negative balances. If you like trading, we recommend that you only choose forex brokers with negative balance protection.
Ready to learn more about forex trading? Check out our education section for more trading articles.
