Negative balance protection. A good or bad thing?

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Since the CHF debacle spread betting brokers have been looking for a way to win business by mitigating risk for their clients.  One new feature that has been introduced rather swiftly is negative balance protection.

What this means is that the broker will supposedly not come after you as a client if you over trade, lose money and end up with a cash deficit on your account.

On the surface this seems like a good thing.  The very nature of spread betting, which allows private clients to take leveraged short bets on stocks and other asset classes could in theory result in infinite losses.  That is, if you are long you can only lose to zero.  If you are short and stock or currency price an go up indefinitely.  Of course, that’s what initial and variation margin are the to protect against and positions are generally closed out before they get into negative equity.

However, in some cases, such as the CHF cap removal or a significant bid being placed on a stock, prices can move a huge amount and highly leveraged positions can wipe an account out instantly.  In many cases spread betting clients are trading with a gross exposure of more than their net worth so there is a clear and obvious financial danger to the client and broker.

Clearly then negative balance protection is a good thing for customers.  It essentially stops them having to pay up on a massive loss.  The broker would take the hit, presumably get a nice bit of PR in the process and win some clients from competitors as they are seen as this month’s nice spread betting broker.

But it’s also a bad thing.  Spread betting is an investment tool and can be used effectively as part of an overall investment strategy.  But in some cases (or most) it’s used by crazy punters trying to beat the market and make money quickly without really understanding the risks.  By putting negative balance protection in place, it’s going to make inexperienced traders even more prone to taking unnecessary risks under the impression that they can’t lose.

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