Negative balance protection
Why must you care about negative balance protection?
Negative balance protection became more important after the Swiss franc crisis in 2011 when 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 do so, the broker can come after you and collect the money you owe for it. So it is important how you or your broker handle this issue.
What is the negative balance protection?
Negative balance protection means that you can't lose more than your deposited money, i.e. you won't owe money to the broker.
Let's say you deposit $1,000 to your account and you buy a share with 5:1 leverage. In this case, you will have a position of $5,000. If there is a market turbulence and your share price drops 7%, you will suffer a 35% loss due to your leverage. This is $1,750 loss in dollars. This loss will eat your $1,000 deposited money and a further $750 which you will owe to the broker. If you do this transaction at a broker which provides a negative balance protection, your loss can't be bigger than the deposited $1,000.
Some brokers provide negative balance protection, some brokers don't.
Negative balance protection was a really hot issue among the regulators in the last few years. Finally, the European Securities and Market Authority announced its new regulation on forex, CFDs and binary options which includes the negative balance protection on a per-account basis. This new regulation will come into force in 2018 summer.