Direct from the desk of Dane Williams.
The only way a forex broker can offer negative balance protection is by being a market maker.
It is impossible for ECN forex brokers truly passing their client’s orders onto LPs within the interbank market to offer negative balance protection.
As such, while a forex broker offering negative balance protection may sound like an excellent marketing tool on the surface, it’s actually not all it’s cracked up to be.
Before I go any further, I need to answer how it’s possible you can lose more than your initial deposit and go over how often it happens.
Starting with the second part, honestly the answer is once in a blue moon.
But all you need to know is that it can and does happen!
Here’s a true story of one such occasion that occurred back in 2014, when EUR/CHF flash crashed.
For over 3 years the Swiss National Bank (SNB) maintained an artificial price peg of 1.20 EUR/CHF.
The market wanted to sell the Euro to what it considered fair value, but the SNB stood firm.
They pissed away their currency reserves propping up the artificially strong Euro until finally the expense could no longer be justified.
Fair enough, the writing was on the wall and was always going to happen.
But yikes, was this poorly communicated and managed.
Without any warning of a timeline or plan to scale down their EUR/CHF buys to avoid a market shock, they pulled the plug.
And boy was the effect catastrophic.
In a single second, EUR/CHF dropped 30%.
Because there just weren’t any buy orders sitting below the peg.
Nobody was game (or stupid) enough to leave sitting buy orders in the market.
This meant that anyone who had been buying at the peg in the expectation it would hold, but set a stop loss order just below, literally had ZERO liquidity to fill.
So what happened was your forex broker’s liquidity provider was forced to slip.. and slip… and slip your order until it found liquidity.
Filling you wherever the market would allow, whether you had the money in your account to cover the loss or not.
Without liquidity in the market, and open risk on their book, your broker had to close the position somewhere.
They took the hit and simply passed it on to traders.
Now you can click the link above and read my overview of IG and FXCM's handling of the flash crash to see that no regular folk were legally forced to pay the ridiculous sums these companies initially asked for.
But this is how you can lose more than your initial deposit and why forex brokers offering negative balance protection became such a big marketing ploy.
As you can see, this wasn’t your forex broker’s fault.
Reputable ECN forex brokers who use LPs to get the best prices for their clients and pass their orders into the interbank market had no say in the matter.
It’s literally impossible for ECN forex brokers who transparently execute trades in this manner to offer negative balance protection for their clients.
If liquidity isn’t in the market to fill your stop loss, then liquidity isn’t in the market.
But in saying that, less trustworthy market makers who take the opposite side of your trades and are actively known for trading against their clients, are able to offer negative balance protection.
They never actually send your orders to the interbank market so can choose to execute them at whichever price they feel like.
As such, ensuring that their clients never go into the negative.
It is made out to be this excellent thing where the broker is on your side.
Yet once again, it’s all just smoke and mirrors from dodgy brokers.
Just another elaborate marketing ploy to suck the retail crowd who don’t fully understand how things work, into funding an account they’re likely to blow up.
Don’t fall for the trap.
Best of probabilities to you.
Posted Using LeoFinance Alpha