By Nathan Boardman
Trading in contracts for difference (also known as “CFD”) is a popular method of investment; however, just like any other type of investment, it is not without its share of risk considerations.
In order to protect your capital from suffering significant losses, it is essential to manage risk effectively when engaging in stock trading. When it comes to lowering their risk exposure, traders have a variety of options available to them, and one of those options is negative balance protection.
Main Highlights
- Brokers under regulation often offer a safety feature known as negative balance protection, which guarantees that traders will not exceed their account balance and incur debt due to trading losses.
- Having this safeguard is crucial in unpredictable market situations when using borrowed funds can result in a deficit in the account; thanks to this protection, the trader’s losses are capped at the original investment, and the account will be brought back to zero.
- Traders can reduce the chance of surpassing their starting funds by staying updated on market conditions, sufficiently funding their trading account for margin needs, and implementing stop-loss orders to end trades at a set price level automatically.
What Does Negative Balance Protection Mean?
Negative balance protection is a mechanism that is implemented by the majority of regulated brokers in order to protect traders from losses that are greater than the total capital that they have invested.
Due to the fact that the brokers will cover any losses that exceed your balance, you will not be exposed to a risk that is greater than the funds that are currently in your account.
What Are the Benefits of Using Negative Balance Protection?
An example of this would be a trader who decided to start a trading position with a significant amount of leverage after investing $100. Regrettably, the market was subject to extreme fluctuations, which resulted in the position being closed against one’s will after a sudden drop in price.
As a consequence of this, the initial investment of $100 was lost entirely, and an additional $20 deficit was incurred as a result of financial leverage.Â
In this scenario, the trader will be required to repay the twenty dollars that is owed to the broker because negative balance protection is not available. The account balance will be reset to zero if the negative balance safeguard is activated, and any losses that are incurred will be limited to a maximum of one hundred dollars.
Therefore, working with a broker that offers negative balance protection is an effective way to reduce the risk you face and ensure that you will stay within the limit of your account balance.
Is There Any Other Way to Prevent Losses That Are Greater Than the Initial Capital?
Market conditions may differ based on the specific financial asset being traded. To avoid potential losses surpassing the initial investment, traders have the option to explore the following three strategies:
1. Stay alert to market conditions
Being vigilant about evolving situations in the financial markets prompts traders to decrease their risk or engage in trading with reduced leverage during periods of high volatility. Unstable markets have the potential to create significant price fluctuations, leading to a possible unfavorable trading outcome.
2. Make sure the trading account is adequately financed
With ample funds in the trading account to cover necessary margins, leveraged positions can have additional flexibility.
3. Establish a stop loss for your trades
Stop losses can help avoid a significant loss by setting a predetermined threshold for acceptable losses. One way to achieve this is by establishing a specific price for your stop-loss, triggering the closure of your trade when that price is reached.
