Why should you care about negative balance protection?
Negative balance protection is offered by most forex and CFD brokers in Europe, the UK and Australia.
It applies if you trade with leveraged products like CFDs, but only retail clients are covered (i.e. professional clients are not).
The concept of negative balance protection came into public focus in 2011 when the Swiss National Bank (SNB) stopped holding its currency against the EUR at a fixed currency rate. 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.
When you have a negative balance, the broker asks you to deposit more money. If you don't comply, the broker can take action to collect the money you owe them.
What is negative balance protection?
Negative balance protection means that you can't lose more money than what is on your account, i.e. you won't owe any money to your broker.
Let's say you deposit $1,000 to your account and you enter a CFD trade with a 5:1 leverage. In this case, you will have a position worth $5,000. If there is market turbulence and your position suddenly drops 25%, you will suffer a $1,250 loss, or 125% of your deposited money, due to the leverage. This means your $1,000 balance won't cover your losses and you would owe the broker $250 – if they didn't provide negative balance protection.
However, If you perform the same transaction at a broker that provides negative balance protection, your loss cannot exceed the deposited $1,000 amount.
Negative balance protection has been a really hot issue among regulators for years. Eventually, the European Securities and Market Authority announced a new regulation on forex, CFDs and binary options, which includes negative balance protection on a per-account basis. This regulation will came into force in mid-2018.