Forex traders are exposed to the risk of price movements and the broker mismanaging their funds. Authorities make regulations to minimize the latter risk. This article outlines the key protections that regulated brokers offer and how to verify them before funding. There is one protection per section below.
Segregated Client Funds
Brokers in the UK, EU, and Australia must separate client funds from their own. Your money must be kept in a different bank account, so the broker can’t use it to cover his rent or the firm’s trading losses.
An administrator can distinguish your funds as the client’s property if the broker becomes insolvent. In general, the money isn’t owed to creditors of the firm. Not all segregation results in a complete refund: record-keeping mistakes or omissions can happen. It can certainly provide you with grounds to recover your balance legally.
Brokers should reconcile client accounts at regular intervals. This means that any discrepancy between what the brokers owe the clients and what they have in their accounts will be visible at this stage.
Investor Compensation Schemes
Some regulators also operate compensation funds that provide compensation to clients if a licensed firm fails. The Financial Services Compensation Scheme in the United Kingdom offers a maximum of £85,000 per person, per firm, for eligible claims. In Cyprus, the Investor Compensation Fund covers up to €20,000 per client of companies with a CySEC licence.
The coverage and claim terms vary from country to country. Check the conditions of coverage of your broker’s licence. Determine if the broker’s entity is covered, as the scheme covers only clients of the licensed entity.
Compensation schemes may apply when an eligible licensed firm fails and cannot return money owed to its clients. They do not compensate you for normal trading losses.
Negative Balance Protection
A speedy market move can cause your account to go negative; that is, you owe the broker money. The UK, EU, and Australian regulators mandate brokers to provide negative balance protection for retail clients trading covered CFD products.
According to this rule, you will only lose the money in your account. If the price difference causes an opening loss that is more than the total equity of the account, the broker swallows the loss.
This is important, especially during news releases and market openings, when prices can cross your stop-loss level. During such times, a stop-loss order may not always be executed at the desired price. The shortfall is made up for with negative balance protection.
Make sure your broker uses it for all types of retail accounts because some broker firms have only a few types of accounts eligible for this.
Leverage Limits and Margin Close-Out
Leverage allows you to use a small size to control a large position, which also increases profits and losses. Regulators also cap the amount of leverage that retail clients can use to reduce the damage. The maximum ratio for major currency pairs is 30:1 according to the rules of the FCA, ESMA, and ASIC. Lower leverage limits apply to minor currency pairs, gold, and other asset classes.
Regulators also impose margin close-out rules. Under the EU retail CFD framework, providers must close out one or more open positions when the funds in a retail client’s CFD account fall to 50% of the minimum margin required for the open positions.
There is also a risk warning that brokers are required to display, detailing the percentage of retail accounts that lose money with that type of broker. This figure can be accessed on the broker’s website.
Capital, Audits, and Complaint Handling
Licensed brokers will have minimum capital requirements, regular financial reporting, and undergo audits. These requirements enable the regulator to judge if a firm is able to fulfil its obligations. If a broker violates terms and conditions, regulators may impose a fine, limit its activity, or revoke its license.
There is also a formal complaints procedure. There shall be a written complaint procedure in place for a licensed broker, and it shall have time limits for response.
If the answer doesn’t address the query, then you can take the matter to an impartial entity like the Financial Ombudsman Service in the United Kingdom or the Australian Financial Complaints Authority in Australia.
An unregulated broker doesn’t provide you with any of these routes.
How to Find Out a Broker’s Protections
Before funding an account, follow these steps:
- Check the broker’s website to locate the license number, and then look it up on the regulatory public register.
- Verify the company name and website address are the same as they appear on the register.
- Explain segregated funds and negative balance protection in the client agreement for terms.
- Figure out whose legal entity your account is under, as different broker groups may have more than one licensed entity.
Independent reviews can assist you in comparison. A detailed Alfa Forex Review will provide information about the regulatory status, charges, and account terms of that broker. You can then compare them to the above-mentioned checklist. Be guided by any review, but verify each fact against the regulator’s own register.
Regulation Does Not Cover the Following
Regulation lowers the risk on the broker’s end, and it puts the risk on you. Even a regulated broker can teach you how to make losses, and there is no rule that ensures you make a profit.
There are differences in protection, too, between countries. Lower capital requirements, lighter oversight, and no compensation scheme are some of the features of a license from a small offshore jurisdiction. The term regulated can mean quite a bit in two separate brokers.
Another danger is clone firms. Fraudsters use the name and license number of a legitimate broker and create a website that looks like the broker’s. Enter the broker’s website address outlined on the register from the regulator, rather than clicking on a link sent in an advert or email.
How to Safeguard Your Own Account
There is a base level set by regulation, and your habits add to that:
- Limit the amount of money risked on each position, like 1%-2% of your account.
- Use a stop loss on each trade.
- Withdraw profit according to a plan to reduce the amount invested with a broker.
- Maintain records of deposits and withdrawals and confirmation of trades.
Summary
Regulated brokers should keep your money separate, provide negative balance protection, restrict leverage, and close out your positions when losses exceed your account balance. Compensation schemes support you in the event of a firm failure. Check the licence on the regulator’s register, read and understand your client agreement, and trade at your own risk.
