Why your broker’s license is very important
Many traders inadvertently register with brokers that have the best offers, the best promotions, and the lowest commissions. Although this looks pretty beneficial from the trader’s perspective, there are actually many aspects of the brokerage that these traders neglect.
One of the most crucial aspects that are often overlooked is the license and regulation of these brokerages in the United States or any other country.
You see, trading and investing is an extremely risky endeavor. Therefore, all clients must have a guarantee that the company that’s providing them the service will not actively act against their best interests. This is done through having government oversight on company operations and a set list of rules that need to be followed to the T.
In case of any form of violation for these rules, the customer has sort of like a safety net via complaints with the regulator, a right to compensation and just having somebody to back them up in court if it leads to such necessities.
But what kind of benefits do you, as a client get when your broker has a license? Well, let’s list those.
This is very important for traders as well, but more so for some than others. For example, the reimbursement policy is one of the most important aspects of a forex broker. Why forex? Because the market is so volatile that the broker could potentially violate a rule that harms their clients without even realizing it. So reimbursement is absolutely vital here to keep the brokers in check.
One thing we can say here is that this also applies to self-regulated forex brokers in the USA as well as government-regulated ones. But make sure that there is still some confirmation from local authorities that these self-regulated entities can be trusted.
The key difference is that self-regulated brokers have to discuss if they want to pay you money (which they never want to) for the sake of reputation. A government-regulated broker is forced into paying you or else they pay a much larger fine or have their executive team face charges. There’s some risk involved but the latter is a much safer option.
Negative balance protection
This is pretty much the safety net we mentioned above. However, the Negative Balance Protection or the NBP for short is usually present on brokerages that allow leverage of some sort.
Leverage is basically borrowed money from the broker that you use to trade with. Should the trade go awry, there is a chance that all of your capital is lost, but you still have the broker’s money left to trade with. This is a very dangerous situation to be in. One thing that investing should never leave you with is debt. Here’s how it will work with a broker that has no NBP.
– You invest $100 and get a 1:10 leverage from the broker, which means your trade is now worth $1000, $900 of which belongs to the broker and should be returned at the end of the trade. You start losing money on a recent trade you made but you’re still confident that it will still come back up. It’s been a week now and the capital you had is gone, so you’re down to just $900 that belongs to the broker. Because there is no NBP the trade continues and you keep on losing the money. Let’s say that you lost it all. You are down $100, but the broker still wants its $900 back. Basically, there was nothing preventing the broker from allowing you to keep losing money, and be sure they will charge interest on that leverage.
Here’s the option with a broker that has NBP and is regulated by a local authority.
– You invest $100 and get a 1:10 leverage like last time. You start trading but start losing money again. The moment you lose your $100, the trade immediately stops. Sure you’re still down $100 but you don’t have to pay the broker back or anything. That’s what NBP is for and that’s what regulators ensure that each broker has.
Regulated brokers are responsible for providing you information regarding any changes in local laws that could affect your trading and investment decisions. This could be the prohibition of an asset (similar to how it happened with Binary Options for example) or just a restructuring within the company that could lead to a different person taking care of your account or something.
An unregulated broker would most likely ignore info disclosure completely, leaving you in the dark and surprised as to why half of your portfolio is now gone.
Overall, a license, in this case, ensures that you have all the necessary information and the tools required to succeed. This is exactly what the broker is supposed to provide and what you’re paying for.
Story by George Keburia