What is negative balance protection in Forex?
Since the swiss franc crash in Jan 2015, the phrase ‘negative balance protection’ has become popular in the retail Forex markets.
In this article, we’re going to talk about what is negative balance protection, the upsides and the downsides to it.
But first, let me me share with you how you can protect yourself from another swiss franc crash.
“This may be a time bomb waiting to explode” – I wrote, one month before the crash.
- You should check the fundamentals of the currency pair you are trading
- Avoid trading pegged currencies, if you want to be 99% safe from such crashes
I go into more detail in the article above, but the background was that the swiss national bank was trying to devalue it’s currency to 0.833 Francs to 1 Euro or less (EURCHF 1.2 floor), because too much capital was flowing into the country and the swiss franc was appreciating more than they deemed necessary.
The ECB made the CHF peg difficult to keep
However, the ECB soon launched its version of devaluation. They needed to make the Euro cheaper to prop up Europe’s Ailing economy and combat low inflation. So the two central banks were directly competing against each other to print more money. One would have to give way.
When it did, it gave way in a very violent manner that left a lot of traders caught on the wrong side with negative balances, because their stops were not filled. Some brokers went bankrupt too, but the signs of turmoil were there a two months prior, when I wrote, “Many brokers have already reduced their leverage on this currency pair to a max of 50:1 because of their expectations of massive volatility”
I think this also highlights the importance of choosing brokers with segregated accounts because in the event of insolvency, your money is safe. – As is the case for Alpari UK
What is negative balance protection?
It means that your account balance never goes below zero.
But how does my account balance go below zero in the first place?
Usually it doesn’t, because the broker has safeguards in place, (such as a margin call). But when a very violent move happens in the currency markets, the broker’s safeguards or your stop loss might not be able to close your trade in time. This is because of the sheer speed of the move.
Thus, price may have moved way beyond your stop loss or margin call close out level, causing the loss to be much larger than expected.
If this loss exceeds the size of your account balance, that is when you will have a negative balance in your account.
Pros and Cons of negative balance protection
This is where negative balance protection comes in. The broker is able to ‘forgive your negative balance’. He allows your account to start from zero again.
“But wait, how is my broker able to ‘forgive my negative balance?'”
In order to forgive your negative balance, your broker must do be either two things:
- Be very magnanimous.
- Or the more likely scenario is that he is taking the other side of your trade. i.e. B-booking you.
In short, B book means the your broker does not send your trades to the real market. He takes the other side of it.
For example, if you buy EURUSD at 1.1, the broker will sell it to you at 1.1. Since 90% of Forex traders lose money, it is profitable for the broker to take the other side of the trade. The fundamental problem is that there is a conflict of interest.
Personally, I would prefer a conflict of interest free trading environment. But I have traded with both types of brokers before, and as long as they don’t mess with your trades (i.e. give you slippage, or delay execution of your trades), I am satisfied.