For traders in stocks and currencies, the worst that can happen to their asset is that it can go to zero.
That would lead to a significant loss. And it is definitely something to be worried about.
But, no one’s really thought of the possibility of their financial asset going beyond zero. In other words, losing all their money and being in debt.
Then, on Monday, April 20, 2020, for the first time in history, the front-month crude price went to zero. And then it kept going.
Companies were literally paying traders to buy oil. There’s an article worth of explanation for why that happened.
But, this lead to many traders suddenly wondering what else can go negative? And what does that mean for your trading balance?
Futures are a bit unique
OK, so, this is a very unique situation, and it has to do with how futures are constructed.
Arguably, future contracts are the oldest financial instrument that we currently use. In its simplest form, it’s a promise to buy something at a future date – a process that doesn’t even require money.
But, we aren’t talking about prehistoric barter, and the current system is quite a bit more sophisticated even if the basics remain the same. While most futures trading is done electronically and is carried out by traders remotely, they still include the requirement to actually deliver the product you are selling.
Most people who trade futures will sell them before the due date comes, so they never take delivery.
A retail trader in New York doesn’t need 10K bushels of corn. However, if someone did have a future contract that was coming due, and nowhere to store the product, they would be willing to sell that contract at a really low price. At a loss, even.
Thus, futures are practically the only financial instrument that can truly go negative, because they have the risk of being worth less than nothing to buyers. Almost everything else simply becomes worthless, and with no one willing to buy, its value is zero.
Stocks, ETFs and the rest
All stocks traded on exchanges are in limited liability companies, which means you as a shareholder cannot owe more than your initial investment. Therefore, it’s legally impossible for a stock to become negative in value.
Similarly with currencies; they carry no obligation with them of having to return value to anyone. So, the worst that can happen to them is that the country of issue no longer recognizes them, and they become worthless.
Bonds also do not carry any additional liability for the holder. What you paid for the bond is the most you will ever have to pay. ETFs could theoretically go negative, but they are always structured so that if the underlying security drops too much, they simply drop to zero and are canceled.
I trade ETFs! Does that mean I could lose more money than my account?
No. Well, if you have a reputable broker that is. All reputable brokers have balance protection.
So even if your trades might go negative, you are stopped out before then. Therefore, the maximum you can lose is what you put into your account.