This article is especially for traders who wants to trade in Europe
You may have noticed that many brokers have recently significantly increased the required margin to open a forex trade. Or, to put it in other words: they have lowered the maximum leverage. This is the result of new rules from ESMA. These rules have been in force since August 1, 2018, and have major implications for forex traders. In this article we explain the new rules and discuss the consequences for you as an active investor.
What is ESMA?
ESMA is the European Securities and Markets Authority. It is possible that you have never heard of this club. ESMA is the umbrella organization of financial supervisory authorities such as the Dutch AFM, the British FCA, the Belgian FSMA, and CySEC. For a long time ESMA did not do much more than exchange information between regulators. Since January 3, 2018, this European financial watchdog has also been given the authority to regulate financial products (temporarily).
One of the first products for which ESMA has used its new power are CFDs (contracts for difference). Because when you trade in forex, you usually do that with CFDs, the rules also affect you. The reason for the new regulations was a study that suggested that more than 80% of private CFD traders suffered losses. (That’s right, because most traders trade without thinking, and do not use information sources such as the articles on our website.)
What are the new rules for forex trading
Under the new ESMA legislation, CFD brokers are no longer allowed to offer high leverage, they have to warn their customers more about the risks of trading, and traders are protected against a negative balance. The rules for leverage are the most important. Brokers regulated in Europe may not offer leverage of more than 30: 1 on the major currency pairs (the ‘majors’) and no more than 20: 1 on other currency pairs. The maximum leverage factor for cryptocurrencies is 2: 1.
In addition to the leverage restrictions, forex and CFD brokers are also required to set the maintenance margin at positions at 50% of the initial margin. If you open a position with 30x leverage, the initial margin is 3.33% (one thirtieth of the position size). If the value of your positions drops to the point where your account is only worth 1.67% of your position (one-sixtieth of the position size), the broker must automatically close your position. Many brokers have already done this, but now the rule has become standard. ( more about this later on how margin trading works exactly.)
Furthermore, ESMA’s new rules state that brokers should warn their customers about the risks, so expect to see many fine print about how risky forex and CFD trading is. To learn how to properly handle the risks of trading, we recommend that you read our articles about risk management (later).
It used to happen that during a rare ‘flash crash’ your forex position with leverage lost value so quickly that the balance in your account became negative. This is prohibited by ESMA. If your positions are not closed quickly enough in the event of a sudden fall, the additional risk is for the broker. You can never lose more money than you have in your trading account.
What do the new rules mean for forex traders
Of the new rules, only the leverage restrictions have a major impact on forex traders. If the leverage is lower, that means that you can increase your profits (and losses) less strongly. This makes it more difficult to earn money from small price changes behind the decimal point. This is a major problem especially for day traders and scalpers. Go ahead: If you open a short position to make 10 pips profit, with 30x leverage this means a profit of max. 3% of your stake.
There is no silver lining to this bad news. If you want to continue scaling professionally, you might want to work for a large investment bank (to whom the new rules do not apply), or emigrate to a country outside the EU. But if you are willing to adjust your trading strategy, there are a number of steps you can take to keep making money from forex:
Trade in more volatile currencies. The more volatile the currency, the greater the percentage price gain that you can make in the short term. Cryptocurrencies are the perfect example of this, with sometimes a 20% profit or loss per day. Exotic currencies such as the South African Rand and the Turkish lira are also extremely volatile.
Deposit more capital into your trading account. We don’t like forex traders to risk more than necessary, but with the new rules you have little choice. Where you used to need 250 euros to trade in one standard lot, you now need more than 3,000 euros for the same position.
Hold positions longer. Instead of looking for positions that earn 10 pips in an hour, it is better to look for positions that earn 100 pips in 3 days. It takes more work to track down such trades, but even with a smaller leverage you can still make good money from it.
Stay rational. Do not take extreme risks to pursue larger profits. Do not risk your entire capital with a single trade. We all earn slightly less with the new rules, but that is better than making a loss.
Regulated and unregulated brokers
With the new ESMA rules in force, there may be a strong temptation to trade through an unregulated broker. Various unregulated brokers are active that try to lure you with higher leverage than is permitted by ESMA. It is important that you do not fall for it. Unregulated brokers are not supervised by a financial authority, and you have no protection whatsoever if the broker wants to run off with your money.
CFDs are complex financial products that, because of leverage, entail a higher risk of loss. Results from the past offer no guarantee for the future. 73% of Markets.com’s private customers lose money by trading. 80.6% of Plus500’s private customers lose money by trading. It is important that you understand how CFDs work and whether you can afford any losses.
By S.van der Tap Pd.Internet.Marketer Founder Of digitalstico.com
Nearly 5 Hours Of Video Training. A Complete Step-by-step Course HERE