In this guide, we explain how negative balance protection works. We go into greater detail about the trading feature and what kind of benefits it provides for crypto traders. The article starts with an explanation of what is negative balance protection (NBP). We continue with the risks involved if NBP is not part of the trading package. We end with platforms that offer the service and how crypto traders can take advantage of it.
What is Negative Balance Protection?
The definition of negative balance protection is quite simple. You can trade assets to the amount available in your balance. If necessary, the website’s AI would close your position at the point when your balance reaches zero.
1. A trader opened up a $2,000 worth of long (buy) position with 5x leverage for bitcoin at the price of $10,000 per coin. The leverage rate means he borrowed an additional $8,00 worth of assets to match 1 BTC.
2. After some time, market trends pushed the price down by 20% towards $8,000 per coin. The decline swallowed up the trader’s capital, leaving only the leverage amount within the order.
3. As a result of the decline, a negative balance protection function would kick in, liquidating the position. With the position closed, NBP ensured that losses will not happen in case of BTC’s further price decline.
If NBP is nonexistent, the position might close at the point where the trader would have a negative balance. Then, the investor would need to deposit money/coins to cover these losses and even more to have funds for trading.
Pros and Cons of Negative Balance Protection
– NBP prevents further losses and negative balance
As mentioned in our example above, the negative protection balance function prevents traders to lose more than what they have. It factors in substantial market changes that can really cripple traders. A negative balance is possible during both bear and bull market movements. Those that short their orders during sudden bull runs lose as much as traders that long during bear runs.
– NBP assist with panic trading period
Additionally, the psychological factor is important as well. Without a foolproof limitation on trades, beginners would be under huge pressure while creating orders. The ability to lose much more than what you have in your balance can be a dangerous situation. The negative protection balance feature allows them to freely test out their strategies with a small amount of funds.
– NBP would close even profitable orders
Whereas crypto trading starters might find benefits in NBP, experienced players might not like the feature. Many pinpoint that NBP can limit their trades by forcing liquidation during high volatility times. 2018’s bear market is proof of that, with many traders losing a lot more than what they have.
The snapshot below shows just how volatile Bitcoin can be at times, surging and rising at alarming speed and level. Thus, it is possible that NBP will close all of your positions even if few are quite profitable.
Example: If the trader has a profitable short position with bitcoin but incurs losses with Ethereum and Ripple, all three positions would close. NBP might close out all your positions if your cumulative P&L is negative.
Plus500 Negative Balance Protection
Plus500 negative balance protection has a function called “Margin Call” that automatically closes positions that near the balance depletion. The function runs in the background, meaning that traders do not need to activate negative balance protection themselves. However, it is also important to mention that users cannot switch it off either. Platform stresses the importance of adequate analysis, as traders are responsible for their portfolio management. The function can close single or all positions, depending on the cumulative P&L results.
AvaTrade Negative Balance Protection
AvaTrade negative balance protection offers a bit more flexible than Plus500, as it tries to offer lenient trading programs for its users. Namely, the platform employs AIs that control liquidation orders as to not allow for negative balances to occur. In rare events that such a situation happens, the platform would fund the account with its own funds. It is a pretty nice feature for beginners that have just entered the crypto market.
eToro Negative Balance Protection
eToro negative balance protection employs a similar system to Plus500’s, taking into account all of your open positions. If your overall trading orders reach balance bankruptcy, your positions are liquidated. NBP service does it automatically, thus limiting losses that beginners might incur during their activities.
Conclusion - Negative Balance Protection
Through this short guide, we answered the question of how does negative balance protection works. Plus500, AvaTrade, and eToro all employ the service, limiting losses to funds held in balance. Although carrying several positives, traders are still expected to take care of their own positions. Risks are ever-present in the crypto market due to high price fluctuations.
If you’re interested in more Crypto Trading Educational articles, please read How to Pay Tax on Crypto Trading and Which is the best free crypto trading education for beginners.