Negative balance protection: what is it and do you need it?

Although you might have seen it mentioned in numerous user guides and broker reviews, you might have wondered what ‘Negative Balance Protection’ is and why so many online brokerages seem to advertise it. In a nutshell, negative balance protection is an account feature that ensures traders do not lose more than the balance available in their account. Given the importance of this safety feature, negative balance protection is often mentioned in any XM Review 2020 and is a feature that reviewers look out for when assessing a broker.

But why would you need this kind of safety feature? Surely you can only ever trade with funds you have available in your investment account.

Given that the majority of brokerage accounts for retail traders allow what is called leverage trading or trading on margin, where you are essentially making trades with amounts greater than what you have available in your account by using borrowed funds, negative balance protection is a safety feature.

Leverage trading is a prevalent form of trading strategy which allows forex traders to profit from even the smallest changes in the relative value of a currency pair, but if the markets turn against you and your trade doesn’t come good, your losses will be amplified. As such, using negative balance protection is the way that traders using leverage, or margin traders, can protect their account from going into a ‘negative balance’ if it does happen. In this sense, we can think of negative balance protection as an essential tool in developing a risk management strategy for trading.

As a way of increasing the protection available for retail trading accounts, negative balance protection has become a ubiquitous feature offered by the majority of online brokerages offering leverage trading. It has partially come as a result of directives issued by financial regulators, particularly within the European Union. They requested that financial firms and brokerages offer some kind of negative balance protection policy and guaranteed stop losses on retail trader accounts.

Novice and inexperienced traders, in particular, should familiarize themselves with what negative balance protection is and when to use it, given that they may not only be unfamiliar with leverage trading but also might not be as able to detect and respond to sudden changes in market behavior. That could leave them at risk if they are trading on leverage, and the market movements suddenly turn against them.

Negative balance protection is an essential way of not only protecting yourself from bad trades but is also a way of managing market volatility more generally. That is particularly true in the forex trading markets, for example, where there can be very high levels of market volatility on a daily basis, which brings with it the possibility of significant fluctuations in the relative prices of currency pairs.

Given how vital negative balance protection is when you are looking for a broker to trade with, if you see a broker offering the feature, it is generally a good sign that they have customer protection at the heart of everything they do. Negative balance protection is an essential feature of any risk management strategy and should be implemented wherever possible.