I keep reading that as a warning before I open an account with any broker that allows you to trade CFDs. How can you lose more than your investment? Does that mean you will owe the broker money if the loss is big?
You might think “how can that happen? Won’t they just close my positions automatically if my margin falls below the required level?”
The answer is, yes they will do that if they can. But sometimes the market moves so fast or gaps completely that they are not able to close out your positions in time, and that can lead to big losses which may exceed the balance of your account, which you are liable for.
Probably the most famous event recently where this happened was in January 2015 when the Swiss National Bank, without any warning, announced it was abandoning its Euro cap policy (which kept the value of the Swiss franc artificially low). The SWF immediately soared in value, gaining an incredible 30% against the Euro in less than 2 hours.
Great if you had a long position in SWF, terrible if you had shorted it. The surprise announcement led to a lack of liquidity that meant positions could not be closed out fast enough, and some ordinary traders, even with modest short positions were suddenly left in hundreds of thousands of debt.
One teacher who had a small, short position was plunged into £280,000 of debt by the adverse move. IG (his broker) did not forgive his debt or anyone else’s who were adversely affected by the move, and several lost their houses, were made bankrupt etc.
HOWEVER, some brokers (mine included) offered ‘negative balance protection’ which means that you can never be liable for more than the balance of your account.
The new ESMA rules, much maligned for their ridiculous leverage caps, do now require regulated brokers to offer Negative Balance Protection to all of their retail clients, a sensible protection in my opinion. So if you trade with an EU regulated broker (as a retail, not professional trader) you get this protection as standard.
But if you trade with a broker outside the EU (eg some of the Australian brokers which are becoming very popular due to their non-ESMA leverages) then you are vulnerable to gapping or other adverse movements putting your account into the negative, unless they specifically offer negative balance protection.
Yes exactly, and for the SNB event many overseas brokers engaged debt collection firms in the UK (or wherever their clients were located). Many were made bankrupt, some settled out-of-court, it was a real shock to many hobby traders who thought they weren’t risking much, but the risk warnings were clearly present on all of the brokers websites and T&Cs.
See this thread when it was all kicking off if you’re interested to see how brokers behave when your losses exceed your account balance:
A few brokers became insolvent and entered administration, Alpari for example. Their administrator, KPMG, ruthlessly and relentlessly pursued clients who owed money as a result of negative balances, and had no hesitation petitioning for a clients bankruptcy if they could not pay.
(By the way, IG is regulated by ESMA so now has negative balance protection as standard for retail clients.)
But brokers such as IC MARKETS, eightcap etc, very good brokers with solid reputations and allow non-ESMA leverage and margin requirements. But, as was the case with most EU brokers before ESMA, they do not have negative balance protection, so you are vulnerable to adverse movements or gapping.
I should point out that events such as the SNB debacle in 2015 are extremely rare, but they do happen.