The European Union has published new regulations applying to retail Forex, CFD, and the few remaining binary options brokerages in its territory. If you have an account with one such brokerage, the regulations will affect you when they come into force during the late spring and summer. This article will outline how the new regulations will impact your bottom line.
Details of the New ESMA Regulations
In March 2018, the European Securities and Markets Authority (ESMA), the financial regulator and supervisor of the European Union, announced new regulations concerning the provision of contracts for differences (CFDs) and binary options to retail investors. It is unclear exactly when the regulations will come into force, but some time in May or June 2018 looks to be the most likely date, and Forex and CFD brokerages located within the European Union (including the United Kingdom, for the time being) will be forced to comply. The regulations will need to be renewed by ESMA every three months to remain in force over the long term.
The regulation concerning binary options is very simple: they may not be sold. In simple terms, this is the end of binary options as a product sold from within the European Union.
The regulations concerning CFDs are more complex but still relatively straightforward. Firstly, there is some confusion as to what exactly is a CFD, with many traders thinking that spot Forex is not considered a CFD and will therefore be exempt from the new regulations. They are wrong: spot Forex is technically defined as a CFD. In fact, every asset you see available for trading at Forex / CFD brokers will most likely be subject to the new regulations.
The new regulations will implement the following changes for retail client accounts (more on who is a retail client; later).
-
The maximum leverage which can be offered will be 30 to 1. That will apply to major currency pairs such as EUR/USD, GBP/USD, USD/JPY, etc.
-
Other currency pairs, major equity indices, and gold will be subject to a maximum leverage of 20 to 1.
-
Individual equities cannot be offered with leverage greater than 5 to 1.
-
Cryptocurrencies are subject to a maximum leverage of 2 to 1.
-
Brokers will be required to provide negative balance protection, meaning it will be impossible to lose more money than you deposit.
-
Brokers will be required to close a clients open positions when the account equity reaches 50% of the required minimum margin by all open positions. This ;margin call; provision can be tricky to understand, so will be explained in more detail later.
-
Bonuses or any other form of trading incentives may not be offered.
-
Brokers will be required to display a standardized risk warning which will include the percentage of their clients who lose money over a defined period.
Understanding the ;Margin Call; Regulation
The best way to understand the 50% margin call provision is to use an example. Imagine a client opens an account with a Forex broker, depositing ;100 in total. The client opens a short trade in EUR/USD, by going short one mini-lot (one tenth of a full lot). One full lot of EUR/USD is worth ;10,000, meaning one mini-lot is worth ;1,000. To find out the minimum margin required to support that trade, we divide the size of the trade (;1,000) by 30, which comes to ;33.33. This is the minimum required margin to maintain the trade. Half of that amount is ;16.67. Now assume the trade goes against the client, with the price of EUR/USD rising above the entry price. As soon as the price rises far enough to produce a floating loss of ;83.33 (;100 - ;16.67), the broker must close the trade out, even if the trade has no stop loss or has not yet reached the stop loss. In theory, this means that a client;s account can never reach zero. Examples involving multiple open trades will be more complex, but will operate according to the same principles.
What Will This Mean for Traders?
The regulations will only apply to ;retail clients;, so you might try to apply to be classed as a professional trader. To get a broker to classify you as anything other than a retail client, you will have to show you have financial qualifications, a large amount of liquid assets, plenty of experience trading, and usually that you also trade frequently. Most traders will be unable to qualify, although it is worth noting that one London-based brokerage, IG Group, has stated that their proportion of clients now classified as recently increased from 5% to 15% of their total customers.
The major impact these regulations will have on traders is simple ndash; the maximum trade size they can possibly make at brokers regulated in the European Union will shrink. Many will say that the maximum leverage limits still offer far more than any trader could need, and I agree. I am wary of leverage and I hate to see anyone using leverage greater than 3 to 1 for Forex under any conditions, or any leverage at all for stocks and cryptocurrencies. Commodities can also fluctuate wildly in value. Too many people forget that the biggest danger in leverage is not overly large position sizing, it is that a ldquo;black swan rdquo; event such as the CHF flash crash of 2015 could happen and wipe out your account through huge price slippage. However, there is another factor that is widely forgotten: why assume that a trader rsquo;s account at one Forex broker is all the money they have in the world? For example, a trader might have $10,000 in the bank. If they deposit $1,000 at a broker offering maximum leverage of 300 to 1, they can trade up to $300,000. At a leverage limit of 30 to 1, that trader will have to deposit their entire $10,000 fund to trade at the same size. In a real sense, that trader might now have to take on more risk to operate in the same way, because if the broker goes bust, while beforehand they might lose $1,000 now they could lose $10,000! Even without negative balance protection, that broker would still have to come after them to try to get an extra $9,000 which they theoretically risk. Yet we saw after the CHF crash that brokers don rsquo;t come after every single client whose losses exceeded their deposit, due to legal costs and reputational issues. This shows that although the stated purpose of the regulation is to protect traders from excessive losses, the story is not as simple as you may think.
Beyond having to deposit more margin, and automatic margin calls, the other major change for traders will be that they will enjoy negative balance protection. This is a positive development which hopefully will make brokerages focus more heavily on the risks they are taking with their business model in the market. At the same time, a possible side effect of the new regulation is the potential increase in average deposits, leading to brokerages being more stable and better capitalized with client funds. Two final notes: brokerages will have to report on their websites the percentages of clients who are losing and making money, although the period over which the statistics must refer to is currently not clear. This will help to shed light on the debate over what percentage of retail traders are profitable, although some brokerages have already released what they claim to be accurate statistics showing that clients with larger account sizes tend to perform better as traders. Additionally, bonuses and promotions will be banned. I welcome this, as not only do they trivialize the serious business of trading, they are almost always a trick offering the illusion of free money whilst preventing traders from withdrawing any profits until a large number of trades are made (read the fine print the next time you squo;).
What If Yoursquo;re Not Happy Remaining in the EU?
Traders with accounts at affected brokers who cannot obtain professional status classification and feel they really need higher leverage than the ESMA limits outlined above might look for a solution by opening accounts with brokers outside the European Union. The most obvious destination would be Australia or New Zealand, where it will still be possible to find reasonably well-regulated Forex brokerages offering leverage in the range of 400 to 1. A recent development that is not talked about much is the growing difficulty of transferring funds to and from Forex brokerages in less tightly regulated jurisdictions. You might decide to open an account with a brokerage in Vanuatu, but you may find that a bank within the European Union might just refuse to send your money there for a deposit. This means that going far offshore, depending upon where you live, may not be a feasible option. In any case, the new regule impossible to live with, and overall there is a compelling case that they are a net benefit to any trader, so why migrate?
Who Trades Forex? | Trading Forex
A big part of understanding any market is knowing who the market participants are and getting a handle on the structure of the market. The Forex market is the largest market by cash volume in the world, with approximately $4 trillion worth of currency changing hands every day. Unlike regulated stock markets which trade in shares of public companies, the Forex market is not centralized, and it is best to think of it as a series of fountains or a wedding cake, with the most important participants at the top, with trades cascading down. The largest participants get the best terms and can move the market with their trades, although as the market is so big, it is difficult for any entity to manipulate. Working in order of size from the top down, the Forex field looks like this.
Central Banks
Central banks are national banks, in charge of issuing and lending the national currency. They are at the very top of the “food chain”. The usually also set monetary policy such as interest rates, and can increase or reduce the supply of their currency. They also usually have enormous reserves of other currencies and stores of value such as gold bullion. This means that they have several powers which when exercised can move the market in their currency dramatically. Probably the best example of this occurred in 2015 when the Swiss National Bank announced a surprise removal of the Swiss Franc’s peg to the Euro, which had the effect of moving that exchange rate by up to 30% in some quotes. Central banks often have policy aims, whether officially stated or not, of preserving their currency’s relative value within certain bands, and they will implement such policies by intervening in the Forex market when the band’s limits are threatened. Note that they are not universally successful: the Bank of England unsuccessfully tried to hold up the value of the British Pound against the German Deutschmark in 1992, but were forced to abandon their attempt after spending more than a billion Pounds in the market. It is much easier for central banks to devalue their currency than it is for them to maintain or increase a value. Central banks also have a role in lending and providing liquidity to the largest banks which serve their nations. If these large banks get in trouble, it is the central bank which must intervene to clean up any mess.Banks
Most of the market volume is traded in the interbank market, i.e. between banks. Banks trade for both themselves and for their clients, which will be listed further down the chain below. The interbank market is dominated by the “big four”: by volume, this is Citibank at 12.9%, JP Morgan and HSBC at 8.8% each, and Deutsche Bank at 7.9%. Banks trade for themselves both as a speculative venture (although the size of this business is decreasing) and to build their own inventory of currency, as well as acting as a dealer to large, professional market participants. As dealer, banks make their profit from the bid/ask spreads which they impose on exchange rates quoted to their clients.Investment Managers and Hedge Funds
The biggest customers of the banks are speculative hedge funds and manager of other investment vehicles. They may want to exchange currencies either to finance purchases of securities denominated in currencies which they do not own, hedge against a risk in future fluctuations in currency exchange rates which could adversely affect their portfolios of securities, or simply to speculate upon such fluctuations for profit. While hedge funds trade in very large volume and get a lot of publicity, the pension fund industry accounts for a larger total of assets under management. However, as their trading style tends to be more conservative, it is the hedge funds as bigger risk-takers which tend to have a bigger influence upon the Forex market.Corporations
Corporations, like investment managers and hedge funds, also deal with banks. Larger corporations tend to deal with the larger banks directly, while smaller businesses will work with smaller banks. Forex brokers are corporations and fit in this niche in the chain of dealing. Many corporations are multinational or at least engage in international trade. Even if they do not, their profits may be exposed to the risk of fluctuations in currency exchange rates. For these several reasons, corporations need to make currency transactions, and are often at a market disadvantage because they are forced into the market: they cannot always pick and choose when they trade. For this reason, trading in Forex derivatives such as swaps and forwards is often engaged in by corporations as an effective way to hedge against such risks well in advance. Note that the total volume of Forex traded by corporations for business purposes is dwarfed by the amount traded by Investment managers and hedge funds for speculative purposes, although it could be argued that many investment managers are trading as hedgers rather than as speculators and so share some elements typically characteristic of corporations.Retail Traders
Unfortunately, we are at the very bottom of the chain, trading on worse terms than every other actor listed above. We need retail Forex brokerages to trade, and these brokers may not even be hedging their risk on our trades. If they are, they will be usually use a bank for their Forex dealing, which in turn is probably using another bank, which may then finally have behind it one of the “big four” or tier 1 banks. At each level, the prices, spreads etc. will slowly worsen. So, who are the hundreds of thousands of people like us who trade Forex with retail brokers? According to survey results presented in 2014:- About 70% male, 30% female. Proportion of women highest in Europe (41% female).
- Median age of 35 - relatively young.
- 35% in Europe, 40% in Asia, only 4% in USA.
- Americans have highest average deposit at over $6,000.
- Breakdown by region: Europe 35%, Asia 24%, Middle East 13%, South America 8%.
- 84% believe it is possible to make positive monthly returns, 30% do.
- Larger accounts tend to be more profitable.
Source
Who Trades Forex? | Trading Forex
A big part of understanding any market is knowing who the market participants are and getting a handle on the structure of the market. The Forex market is the largest market by cash volume in the world, with approximately $4 trillion worth of currency changing hands every day. Unlike regulated stock markets which trade in shares of public companies, the Forex market is not centralized, and it is best to think of it as a series of fountains or a wedding cake, with the most important participants at the top, with trades cascading down. The largest participants get the best terms and can move the market with their trades, although as the market is so big, it is difficult for any entity to manipulate. Working in order of size from the top down, the Forex field looks like this.
Central Banks
Central banks are national banks, in charge of issuing and lending the national currency. They are at the very top of the “food chain”. The usually also set monetary policy such as interest rates, and can increase or reduce the supply of their currency. They also usually have enormous reserves of other currencies and stores of value such as gold bullion. This means that they have several powers which when exercised can move the market in their currency dramatically. Probably the best example of this occurred in 2015 when the Swiss National Bank announced a surprise removal of the Swiss Franc’s peg to the Euro, which had the effect of moving that exchange rate by up to 30% in some quotes. Central banks often have policy aims, whether officially stated or not, of preserving their currency’s relative value within certain bands, and they will implement such policies by intervening in the Forex market when the band’s limits are threatened. Note that they are not universally successful: the Bank of England unsuccessfully tried to hold up the value of the British Pound against the German Deutschmark in 1992, but were forced to abandon their attempt after spending more than a billion Pounds in the market. It is much easier for central banks to devalue their currency than it is for them to maintain or increase a value. Central banks also have a role in lending and providing liquidity to the largest banks which serve their nations. If these large banks get in trouble, it is the central bank which must intervene to clean up any mess.Banks
Most of the market volume is traded in the interbank market, i.e. between banks. Banks trade for both themselves and for their clients, which will be listed further down the chain below. The interbank market is dominated by the “big four”: by volume, this is Citibank at 12.9%, JP Morgan and HSBC at 8.8% each, and Deutsche Bank at 7.9%. Banks trade for themselves both as a speculative venture (although the size of this business is decreasing) and to build their own inventory of currency, as well as acting as a dealer to large, professional market participants. As dealer, banks make their profit from the bid/ask spreads which they impose on exchange rates quoted to their clients.Investment Managers and Hedge Funds
The biggest customers of the banks are speculative hedge funds and manager of other investment vehicles. They may want to exchange currencies either to finance purchases of securities denominated in currencies which they do not own, hedge against a risk in future fluctuations in currency exchange rates which could adversely affect their portfolios of securities, or simply to speculate upon such fluctuations for profit. While hedge funds trade in very large volume and get a lot of publicity, the pension fund industry accounts for a larger total of assets under management. However, as their trading style tends to be more conservative, it is the hedge funds as bigger risk-takers which tend to have a bigger influence upon the Forex market.Corporations
Corporations, like investment managers and hedge funds, also deal with banks. Larger corporations tend to deal with the larger banks directly, while smaller businesses will work with smaller banks. Forex brokers are corporations and fit in this niche in the chain of dealing. Many corporations are multinational or at least engage in international trade. Even if they do not, their profits may be exposed to the risk of fluctuations in currency exchange rates. For these several reasons, corporations need to make currency transactions, and are often at a market disadvantage because they are forced into the market: they cannot always pick and choose when they trade. For this reason, trading in Forex derivatives such as swaps and forwards is often engaged in by corporations as an effective way to hedge against such risks well in advance. Note that the total volume of Forex traded by corporations for business purposes is dwarfed by the amount traded by Investment managers and hedge funds for speculative purposes, although it could be argued that many investment managers are trading as hedgers rather than as speculators and so share some elements typically characteristic of corporations.Retail Traders
Unfortunately, we are at the very bottom of the chain, trading on worse terms than every other actor listed above. We need retail Forex brokerages to trade, and these brokers may not even be hedging their risk on our trades. If they are, they will be usually use a bank for their Forex dealing, which in turn is probably using another bank, which may then finally have behind it one of the “big four” or tier 1 banks. At each level, the prices, spreads etc. will slowly worsen. So, who are the hundreds of thousands of people like us who trade Forex with retail brokers? According to survey results presented in 2014:- About 70% male, 30% female. Proportion of women highest in Europe (41% female).
- Median age of 35 - relatively young.
- 35% in Europe, 40% in Asia, only 4% in USA.
- Americans have highest average deposit at over $6,000.
- Breakdown by region: Europe 35%, Asia 24%, Middle East 13%, South America 8%.
- 84% believe it is possible to make positive monthly returns, 30% do.
- Larger accounts tend to be more profitable.
Source
Who Trades Forex? | Trading Forex
A big part of understanding any market is knowing who the market participants are and getting a handle on the structure of the market. The Forex market is the largest market by cash volume in the world, with approximately $4 trillion worth of currency changing hands every day. Unlike regulated stock markets which trade in shares of public companies, the Forex market is not centralized, and it is best to think of it as a series of fountains or a wedding cake, with the most important participants at the top, with trades cascading down. The largest participants get the best terms and can move the market with their trades, although as the market is so big, it is difficult for any entity to manipulate. Working in order of size from the top down, the Forex field looks like this.
Central Banks
Central banks are national banks, in charge of issuing and lending the national currency. They are at the very top of the “food chain”. The usually also set monetary policy such as interest rates, and can increase or reduce the supply of their currency. They also usually have enormous reserves of other currencies and stores of value such as gold bullion. This means that they have several powers which when exercised can move the market in their currency dramatically. Probably the best example of this occurred in 2015 when the Swiss National Bank announced a surprise removal of the Swiss Franc’s peg to the Euro, which had the effect of moving that exchange rate by up to 30% in some quotes. Central banks often have policy aims, whether officially stated or not, of preserving their currency’s relative value within certain bands, and they will implement such policies by intervening in the Forex market when the band’s limits are threatened. Note that they are not universally successful: the Bank of England unsuccessfully tried to hold up the value of the British Pound against the German Deutschmark in 1992, but were forced to abandon their attempt after spending more than a billion Pounds in the market. It is much easier for central banks to devalue their currency than it is for them to maintain or increase a value. Central banks also have a role in lending and providing liquidity to the largest banks which serve their nations. If these large banks get in trouble, it is the central bank which must intervene to clean up any mess.Banks
Most of the market volume is traded in the interbank market, i.e. between banks. Banks trade for both themselves and for their clients, which will be listed further down the chain below. The interbank market is dominated by the “big four”: by volume, this is Citibank at 12.9%, JP Morgan and HSBC at 8.8% each, and Deutsche Bank at 7.9%. Banks trade for themselves both as a speculative venture (although the size of this business is decreasing) and to build their own inventory of currency, as well as acting as a dealer to large, professional market participants. As dealer, banks make their profit from the bid/ask spreads which they impose on exchange rates quoted to their clients.Investment Managers and Hedge Funds
The biggest customers of the banks are speculative hedge funds and manager of other investment vehicles. They may want to exchange currencies either to finance purchases of securities denominated in currencies which they do not own, hedge against a risk in future fluctuations in currency exchange rates which could adversely affect their portfolios of securities, or simply to speculate upon such fluctuations for profit. While hedge funds trade in very large volume and get a lot of publicity, the pension fund industry accounts for a larger total of assets under management. However, as their trading style tends to be more conservative, it is the hedge funds as bigger risk-takers which tend to have a bigger influence upon the Forex market.Corporations
Corporations, like investment managers and hedge funds, also deal with banks. Larger corporations tend to deal with the larger banks directly, while smaller businesses will work with smaller banks. Forex brokers are corporations and fit in this niche in the chain of dealing. Many corporations are multinational or at least engage in international trade. Even if they do not, their profits may be exposed to the risk of fluctuations in currency exchange rates. For these several reasons, corporations need to make currency transactions, and are often at a market disadvantage because they are forced into the market: they cannot always pick and choose when they trade. For this reason, trading in Forex derivatives such as swaps and forwards is often engaged in by corporations as an effective way to hedge against such risks well in advance. Note that the total volume of Forex traded by corporations for business purposes is dwarfed by the amount traded by Investment managers and hedge funds for speculative purposes, although it could be argued that many investment managers are trading as hedgers rather than as speculators and so share some elements typically characteristic of corporations.Retail Traders
Unfortunately, we are at the very bottom of the chain, trading on worse terms than every other actor listed above. We need retail Forex brokerages to trade, and these brokers may not even be hedging their risk on our trades. If they are, they will be usually use a bank for their Forex dealing, which in turn is probably using another bank, which may then finally have behind it one of the “big four” or tier 1 banks. At each level, the prices, spreads etc. will slowly worsen. So, who are the hundreds of thousands of people like us who trade Forex with retail brokers? According to survey results presented in 2014:- About 70% male, 30% female. Proportion of women highest in Europe (41% female).
- Median age of 35 - relatively young.
- 35% in Europe, 40% in Asia, only 4% in USA.
- Americans have highest average deposit at over $6,000.
- Breakdown by region: Europe 35%, Asia 24%, Middle East 13%, South America 8%.
- 84% believe it is possible to make positive monthly returns, 30% do.
- Larger accounts tend to be more profitable.
Source
Who Trades Forex? | Trading Forex
A big part of understanding any market is knowing who the market participants are and getting a handle on the structure of the market. The Forex market is the largest market by cash volume in the world, with approximately $4 trillion worth of currency changing hands every day. Unlike regulated stock markets which trade in shares of public companies, the Forex market is not centralized, and it is best to think of it as a series of fountains or a wedding cake, with the most important participants at the top, with trades cascading down. The largest participants get the best terms and can move the market with their trades, although as the market is so big, it is difficult for any entity to manipulate. Working in order of size from the top down, the Forex field looks like this.
Central Banks
Central banks are national banks, in charge of issuing and lending the national currency. They are at the very top of the “food chain”. The usually also set monetary policy such as interest rates, and can increase or reduce the supply of their currency. They also usually have enormous reserves of other currencies and stores of value such as gold bullion. This means that they have several powers which when exercised can move the market in their currency dramatically. Probably the best example of this occurred in 2015 when the Swiss National Bank announced a surprise removal of the Swiss Franc’s peg to the Euro, which had the effect of moving that exchange rate by up to 30% in some quotes. Central banks often have policy aims, whether officially stated or not, of preserving their currency’s relative value within certain bands, and they will implement such policies by intervening in the Forex market when the band’s limits are threatened. Note that they are not universally successful: the Bank of England unsuccessfully tried to hold up the value of the British Pound against the German Deutschmark in 1992, but were forced to abandon their attempt after spending more than a billion Pounds in the market. It is much easier for central banks to devalue their currency than it is for them to maintain or increase a value. Central banks also have a role in lending and providing liquidity to the largest banks which serve their nations. If these large banks get in trouble, it is the central bank which must intervene to clean up any mess.Banks
Most of the market volume is traded in the interbank market, i.e. between banks. Banks trade for both themselves and for their clients, which will be listed further down the chain below. The interbank market is dominated by the “big four”: by volume, this is Citibank at 12.9%, JP Morgan and HSBC at 8.8% each, and Deutsche Bank at 7.9%. Banks trade for themselves both as a speculative venture (although the size of this business is decreasing) and to build their own inventory of currency, as well as acting as a dealer to large, professional market participants. As dealer, banks make their profit from the bid/ask spreads which they impose on exchange rates quoted to their clients.Investment Managers and Hedge Funds
The biggest customers of the banks are speculative hedge funds and manager of other investment vehicles. They may want to exchange currencies either to finance purchases of securities denominated in currencies which they do not own, hedge against a risk in future fluctuations in currency exchange rates which could adversely affect their portfolios of securities, or simply to speculate upon such fluctuations for profit. While hedge funds trade in very large volume and get a lot of publicity, the pension fund industry accounts for a larger total of assets under management. However, as their trading style tends to be more conservative, it is the hedge funds as bigger risk-takers which tend to have a bigger influence upon the Forex market.Corporations
Corporations, like investment managers and hedge funds, also deal with banks. Larger corporations tend to deal with the larger banks directly, while smaller businesses will work with smaller banks. Forex brokers are corporations and fit in this niche in the chain of dealing. Many corporations are multinational or at least engage in international trade. Even if they do not, their profits may be exposed to the risk of fluctuations in currency exchange rates. For these several reasons, corporations need to make currency transactions, and are often at a market disadvantage because they are forced into the market: they cannot always pick and choose when they trade. For this reason, trading in Forex derivatives such as swaps and forwards is often engaged in by corporations as an effective way to hedge against such risks well in advance. Note that the total volume of Forex traded by corporations for business purposes is dwarfed by the amount traded by Investment managers and hedge funds for speculative purposes, although it could be argued that many investment managers are trading as hedgers rather than as speculators and so share some elements typically characteristic of corporations.Retail Traders
Unfortunately, we are at the very bottom of the chain, trading on worse terms than every other actor listed above. We need retail Forex brokerages to trade, and these brokers may not even be hedging their risk on our trades. If they are, they will be usually use a bank for their Forex dealing, which in turn is probably using another bank, which may then finally have behind it one of the “big four” or tier 1 banks. At each level, the prices, spreads etc. will slowly worsen. So, who are the hundreds of thousands of people like us who trade Forex with retail brokers? According to survey results presented in 2014:- About 70% male, 30% female. Proportion of women highest in Europe (41% female).
- Median age of 35 - relatively young.
- 35% in Europe, 40% in Asia, only 4% in USA.
- Americans have highest average deposit at over $6,000.
- Breakdown by region: Europe 35%, Asia 24%, Middle East 13%, South America 8%.
- 84% believe it is possible to make positive monthly returns, 30% do.
- Larger accounts tend to be more profitable.
Source
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