A relatively straightforward concept, negative balance protection (NBP) simply means that you can’t lose any more money than is in your account. So, if you have US$1000 in your account, for example, you can’t lose more than that.
Imagine you have US$1000 in your account and you enter a CFD trade with 5:1 leverage. That would give you a position size of US$5000, and if it suddenly dropped by 50%, you would be looking at a US$2500 loss. Given your balance of US$1000, that would leave a shortfall of US$1500 that you would be liable to pay the broker if your account did not have NBP. Moreover, you could be liable to pay interest on any debt, increasing the cost even further. However, if you trade with a broker that provides negative balance protection, your loss cannot exceed the deposited sum of US$1000.
NBP is particularly important for new traders, who may be unfamiliar with how rapidly markets can move during general market volatility or even at the opening and closing of the trading day or on the back of unexpected news.
NBP also allows new traders to try out different trading strategies in the knowledge that they won’t go into debt. At the same time, taking advantage of NBP does not limit any potential gains to be made.
Not all brokers guarantee NBP
Brokers in some, but not all, jurisdictions are required to provide NBP. While providers of leveraged products in the UK, the EU and Australia must, by law, provide NBP, brokers in South Africa are not subject to the same requirement.
Moreover, while brokers in Nigeria and other jurisdictions may say they offer negative balance protection, you may have to request it. That’s because NBP won’t always be offered automatically when you open an account. So, before selecting a broker, you should research prospective firms carefully to find the policies and services that best fit your needs. Remember that if you opt for a brokerage firm that does not offer negative balance protection, you are exposing yourself to unnecessary financial risk. That is easily avoided by choosing a broker that guarantees NBP.
Some brokers seek to entice new customers to open accounts by offering NBP for an introductory period only. When researching brokers, you should ensure that the broker you are considering does not offer negative balance protection only for a trial period. That’s because once the grace period expires, you will be liable for any negative balances carried by your account.
Lower-tier regulators and NBP
The regulatory regime in terms of NBP varies across lower-tier regulators. The Securities Commission of The Bahamas announced in 2020, amid a general tightening of the regulatory regime, that brokers registered in its jurisdiction would be required to offer NBP to clients. However, the Financial Services Commission of Mauritius does not require brokers to offer NBP, and nor does the Financial Services Authority of Seychelles or the International Financial Services Commission of Belize.
