Negative balance in forex trading account could actually happen. Hence the questions, how retail forex traders can avoid negative balance? Do we really have to pay back what we owe forex brokers in the event of negative balance?
Many traders wonder, can a forex trading account turn negative? Leverage trading opens the possibility for negative balance to occur because traders could owe more than the amount of funds that are available in his balances. Seen from this perspective, worries over negative balance in forex account make sense.
What's more, as shown by what happened on Black Thursday (January 15th, 2015), negative balance in forex could actually happen. Hence the questions, how retail forex traders can avoid negative balance? Do we really have to pay back what we owe forex brokers in the event of negative balance?
How Negative Balance in Forex Trading Happens
Negative balance in forex trading account could happen if there are no brakes to stop excessive losses. Those brakes could be Margin Call (MC) or Stop Loss (SL) setups.
Some brokers enacted Margin Call limit where floating positions will be stopped automatically at a loss when the figures of probable losses touched the limit. Because of the possibility of losing one's account due to MC, the limit often avoided by forex traders.
Though actually, Margin Call in account setting can prevent your account balance to be wiped out in an instant and or coming to negative territory. The same goes for Stop Loss that often being ignored by traders, although it supports their risk management.
By applying Margin Call and Stop Loss levels, traders can avoid negative balance in forex trading.
However, there are instances when SL, Margin Call, or the likes, did not work; as happened in the aforementioned Black Thursday. The sudden removal of CHF's Euro peg by the SNB hit the forex industry with extreme market volatility that had resulted in millions of dollars of losses and the closure of a number of forex brokers.
It is very rare, but there are possibilities for such things to happen following the release of surprisingly influential news.
EUR/CHF dropped more than 40% in just a few minutes after SNB's announcement, and that caused trading platforms in major banks to froze. Consequently, there is a huge gap between where the price was before the crash and where it is after the crash. Because during crashes, the platform froze, so MC and SL were useless to stop excessive losses.
Deutsche Banks' Autobahn system, for instance, was shut down for some time. Many brokers drew quotes from major banks like this, and as a result, stop loss became dysfunctional and profit targets broke down due to the price gaps between quotes.
In addition, liquidity from major banks was reported to be practically nonexistent, which made any steps to counter losses became impossible.
The use of leverage also contributed heavily to the post-SNB turmoil. When brokers lent funds to traders, traders simply have to provide a small amount of money in order to trade with bigger size of positions.
In incidents like this when many traders suffered losses, traders only have to bear a small amount of it, while the brokers have to bear a much bigger burden, particularly when hedging failed as well.
The result was numerous complaints of deficits both in trader and broker accounts. Excel Markets (New Zealand), Global Brokers NZ (affiliated with Excel Markets), Alpari UK, Liquid Markets (UK), and Boston Prime (UK) are among the forex brokers that ended up in bankruptcy.
In global technical failure like this, it is up to each broker whether they are going to respect clients' SLs and erase negative balances or not.
Why Negative Balance Protection is Important
As seen from the Black Thursday as well, most global forex brokers chose to forgive negative balance. The move was good for forex traders, but why did they do that?
Global forex broker market share spanned all over the world. Hence, it limits their ability to collect client's debts while the broker itself and their client reside in different jurisdictions. In situations when a broker insists on it, the client could simply shrug it off and go on to other brokers.
In order to prevent such things, even forex brokers who do not have Negative Balance Protection clause often decided to end negative balance peacefully by giving up on it. In this case, Dukascopy and OANDA are two of the most prominent examples.
The reason above has made negative balance in forex trading a relatively minor risk that rarely occurs. Brokers usually decide to simply turn negative balance to zero rather than demanding payment. That way, clients will be relieved and free to deposit their funds and trade forex again.
Not All Broker Offer Negative Balance Protection
However, there are times when your broker might demand clients to be responsible and pay back what is owed as reflected in their account's negative balance. Forex.com and FXCM were each reported to send notices for clients to 'fulfill their responsibilities' in reverting the negative balance in forex trading account.
It could be because the regulation abided by the broker itself forbid liquidation of negative balance in forex trading, or because the broker suffered financial troubles as well. In these circumstances, what could a forex trader do?
- If your broker has clearly stated clauses about Negative Balance Protection, then clients have the right to refuse to pay back by quoting the clause. But commonly, such brokers will automatically turn negative balances into zero some time afterward, or after clients send special requests.
- If your broker has not promised Negative Balance Protection but is located in different countries with the client, then the client could be free to ignore their demands. As clients that reside in different jurisdictions with their broker will find it difficult to sue naughty brokers, brokers that reside in different jurisdictions with their clients will find it difficult to sue their clients for negative balances too. The clients certainly will not be able to trade with the broker, but he could still trade with another.
- If a broker has not promised Negative Balance Protection and is located in the same jurisdiction as their client, then the broker could sue the client all the way to the court. If it happens, then of course the client has to follow the law and might have to fulfill his liabilities in the end.
In the end, all of these will be determined by your own broker. Just talk about it with them. Can your account suffer negative balance? and what will they do if such things happen?
Each broker's policies are different, but a bonafide forex broker will state its stances on the possibility of negative balance in forex trading account without many asterisks.
Brokers Providing Negative Balance Protection
Now you know that negative balance protection may not be offered by all brokers. However, several reputable brokers do provide this protection to their clients. Here are a few well-known brokers that typically offer negative balance protection:
- eToro: eToro is a popular social trading platform that offers negative balance protection to its clients. They have implemented measures to ensure that traders cannot lose more money than they have deposited into their trading accounts.
- Plus500: Plus500 is a CFD trading platform that also provides negative balance protection. They have designed their risk management systems to prevent clients' account balances from going into the negative.
- IG Group: IG is a well-established broker that offers a range of trading services, including forex and CFDs. They have negative balance protection in place to safeguard their clients from excessive losses.
- XM: XM is a forex and CFD broker that offers negative balance protection to its clients. They have implemented risk management measures to prevent clients from incurring negative balances.
- Pepperstone: Pepperstone is another popular forex and CFD broker that provides negative balance protection. They have mechanisms in place to ensure that clients' account balances do not go below zero, protecting them from owing money.
It's worth noting that broker policies and offerings can change over time, so it's always a good idea to verify the availability of negative balance protection with a broker before opening an account. Additionally, each broker may have specific terms and conditions associated with their negative balance protection, so it's important to review those details carefully.
To understand the mechanism behind the negative balance protection, see an interesting insight into how negative balance protection works in forex brokers.