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Written by Chris Bailey (TheDaxTrader.co.uk)

Can I Still Trade After ESMA?

This is such a common question at the moment.

The new ESMA regulation will specifically impact on retail traders of Forex & CFD & binary options in the European Union. This new regulation will specifically impact on ‘retail’ traders using an ‘EU regulated broker’.

The European Securities and Markets Authority (ESMA) have now published their latest regulations. These new regulations concern all CFD brokers in the European Union. The most significant change that will happen, as a result of this new regulation, is that retail traders will no longer be able to trade with the current levels of leverage available.

This article aims to cover:

This is a simple overview of how this new regulation will affect traders. Please ensure you read up on the regulations yourself to make sure you are prepared.

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Who is affected?

EU regulated brokers and more importantly retail traders.

If you are a retail trader and you use a broker that is regulated in the European Union, then you are affected by these changes.

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So What’s Happening?

ESMA, the European Securities and Markets Authority (an independent European regulatory agency aiming to maintain safety and stability within the European financial system) are reducing the maximum leverage being offered to retail clients. As a result, this will heavily increase margin requirements for retail traders.

So let’s look at the leverage limits.

Leverage limits on the opening of a position by a retail client will now range from 2:1 up to a maximum of 30:1, depending on the volatility of the underlying market. These are the new limits:

Many traders are asking for what markets are defined as major and what markets are defined as minor. ESMA does have some information on this classification and there is also a section below covering that question.

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What is a Retail Client or a Retail Trader?

It’s important to understand that these regulations ONLY apply to retail clients/retail traders.

The simplest definition of a retail trader would be Individuals who trade their own money and do not have professional trader status with their broker. The default classificaton of an individual trader is a 'retail' trader, unless they qualify for a different classification (such as a 'professional' trader.

Many traders trade with their own money using a brokerage account, and these individuals would most often be classed a retail trader. Some traders are able to apply for (or are given) professional trader status based on their monthly volume traded, or account balance, or professional capacity.  

But overall, the majority of individual traders are classed as ‘retail traders’. The new ESMA regulations impacts on retail traders.

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Why Are ESMA Doing This?

Because too many retail traders are losing too much money, both currently and historically.

Retail traders have historically lost money trading CFDs and the ESMA regulations are trying to protect consumers. This regulation comes from analysis into the laughable results that retail traders have achieved over the last 10-15 years (you’ve probably heard the statistics right: 95% of all traders fail? Well, it might not be that high, but the number of losing traders is still worryingly high for the regulators).

Here's a video that one of our traders shared in the channel.

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When Does This All Start?

The new regulation will be effective officially from Wednesday 1st August 2018.

It is widely expected that brokers will be announcing their changes very soon with the majority of brokers expected to implement their changes a few days before the 1st August.

It is essential that you as a trader understand how these regulations will impact you (if you do not know already).

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How Will The Leverage Reduction Affect Me?

If you are a retail trader, as many of you may be, it means that you may need more money in your trading account to open the trades you have been opening. Or you may need more money in the account to finance the margin requirement on DAX trades after the August implementation.

For example, to trade the DAX30 with IG at the moment at £1 per point, you have a margin requirement of £63 (think of it like a refundable deposit for the trade – I’ll go into specifics below).
I believe with IG that means you would have 200:1 leverage.

Another example is FXCM.
To trade DAX30 with FXCM at the moment at £1 per point, you will need approximately £148 of margin in the account. I believe that this is around 86:1 leverage.

However, when the new regulations are effective, from the 1st of August, that same trade will require approximately £630 of margin in the account, because the maximum leverage will be 20:1 for the DAX.

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What Do You Mean by Margin Requirement?

You are required to maintain a minimum of 50% available margin at all times.

So you have to understand how to calculate the available margin percentage. I think most brokers automatically provide this information anyway, but it’s good practice to know your own numbers because it helps for when you are planning a trade.

Available Margin = ( Equity – Margin Used ) / Equity
[We multiple this number by 100 to make it a percentage]

Equity = Account Balance – All open position profit and losses. This means that if you were to close out all of your trades right now, your balance would become whatever you equity is right now.

Margin Used is the amount of margin required from each individual trade. Your platform should provide this, or your broker will provide it to you if you ask for it.

Example 1

If your balance is £10,000 and let’s say that you have five open positions running at a total loss of £95, then your equity is £9,915.

Let’s also say that those five trades require £3,250 margin, then we can calculate our Available Margin % (below).

Available Margin % = ( 9,915 - £3,250 ) / £9,915 = 0.6722
Multiply this by 100 and we get 67.22% available margin.

Example 2

Your balance is 10k, you have five trades open running at a loss of £750. The trades require £3,250 of margin. What is your available margin percentage?

£10,000 - £750 = £9750

(£9,750  - £3,250 ) / £9,750  à and then multiplied by = 66.5%

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So How Much Money Will I Need?

It completely depends on how you trade.

If you are trading the DAX30 at £1 per point, then it will require a minimum of £630 in margin. Therefore your account will need to be over double that (with a comfortable buffer) to ensure that you don’t receive a margin call when the position goes into drawdown.

I would image that £1,500 - £2,000 is the absolute minimum in this situation and this assumes that you will not be opening multiple trades, at the same time, on different markets.

If you have four or five trades open, the margin you require will quickly add up and it’s more likely that you need nearer to £10,000 as a minimum account size.

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Will The Changes Happen Straight Away?

It’s difficult to say for sure.

It makes sense for brokers to gradually make the changes to get traders used to it, building up to the 1st August. I suspect that brokers will use their monthly updates to drip feed the ‘pain’ of the increased margin.

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What is Leverage & Margin

Leverage is the result of using borrowed capital as a source of funding when investing to ‘magnify’ potential returns.

So trading with a broker that offers 100:1 leverage (also known as 1%) means that you only need to have 1% of the value of that transaction in your account. Trading with a broker that offers 400:1 leverage (also known as 0.25%) means you only need to have 0.25% of the value of that transaction in your account.

The benefits of leverage are that you can have a small account and magnify your potential profits by placing large trades relative to your account size. The downsides are that your losses will also be magnified and you can easily wipe your account out.

Margin is the amount of money you personally need in your account to open a new ‘leveraged’ trade. So margin is that 1% or that 0.25% we discussed previously. That would be your ‘margin requirement’. If you don’t have sufficient margin in your account, then you cannot open that trade.

Here’s an example: A retail trader has a broker account with a company offering leverage of 100:1 (which is 1%). The trader wants to trade €100,000 of currency (let’s say 1 lot of EURUSD), with a margin of 1%. Therefore the trader will only have to deposit $1,000 into her or his margin account. That is 1% of the €100,000.

This allows clients with limited trading capital to enter the market and invest and enlarge their investment. It requires discipline, bankroll management and skill.

Trading with a margin account offers a trader leverage.

How is leverage calculated?

Leverage = Notional Volume / Margin Required

The Notional Volume is the actual ‘value’ of the trade. What does that mean? Well, in regards to the DAX it is currently valued around €13,000, so when we buy a contract on the DAX, we are buying a 'micronized' contract and other indices, there is often a universal ‘multiplier’ to apply to the value of the index in order to work out the notional value.

In the case of the DAX, it is currently 0.1, but double check that with your broker.

So the notional volume of 1 dax contract = 13,000 x 0.1 = 1,300

If your margin for a single contract is £65, then your leverage is £1,300 / 65 = 20

20:1

Some other brokers offer different leverage, so it may impact you differently.

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What about If I Have Open Positions At The Change?

If you have positions open already, and you are a retail client, then they will be affected.

Most brokers will inform you of when the margin requirements will change, so hopefully you will have time to plan around it. But the short answer is that, yes, your positions will be affected if you have any positions open when the requirements change.

Unless of course that you apply for professional status and are accepted. In which case, your leverage will remain as it was.

If you do not qualify for professional status, then you will be classed as a retail client.

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Is This Law? Is It Final?

These regulations are classed as an ‘intervention’. Therefore they are not permanent at the moment. They are in force for three months.

After three months, it’s difficult to predict the outcome, but ESMA can ‘extend’ it for a further three months, and then extend for another three months and so on.

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So What Can We Do Now?

It depends on which category you fall into.

These regulations are coming into force, we just do not see the full impact yet, so it’s very easy to ignore it and think “it’ll be fine”. But in all seriousness, this may cause many of you to stop trading the DAX, because it will become prohibitively expensive to trade the way you have been trading.

TheDaxTrader.co.uk understands this, which is why it has started looking at FTSE and DOW as well as FX markets.

If you decide that you can continue trading, then it’s certainly not the end of the world. Many of you will still be comfortable with your account size. Many of you will be able to absorb the additional margin requirements. Many of you may choose to remain a retail client, even though we qualify for professional status. There are options and this is not the end of the road.

You may need to adopt some changes to your current behaviours and routines. Here are some examples of ideas that are worth exploring.

  1. Always use a stop loss, otherwise you cannot calculate your risk
  2. Define your bankroll management policy and become disciplined in using it
  3. Ensure you have adequate capital to ensure you’re available margin is high
  4. Considering putting more money into your margin account
  5. Reduce your trade size/volume
  6. Consider trading the EuroStoxx or FTSE or alternative index
  7. Unethical: Consider using a broker that is not EU regulated (Asia, Australia, US)
  8. Become registered as a professional trader (qualifying criteria permitting)

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Retail Client vs Professional Client

It is unlikely that you can have both types of classification of account with the same broker. So you will need to make a decision on which type you want.

According to the regulators, retail clients are common private clients with average experience and knowledge, perhaps low capital, or perhaps just beginners. The retail client classification is the ‘default’ classification of a trader who does not qualify for, or has not applied for, professional status.

Professional clients are extremely experienced customers who can act with large sums of capital and correctly assess the risks involved in a high-leveraged trading arena. However Professional status must be applied for.

PROFESSIONAL CLIENTS

You need to prove two of these three things:

  1. 1. You need sufficient trading experience with either your current broker or another broker. This experience is measured by your trading volume. It is normally 10 lots per quarter over the last 4 quarters.
  2. 2. Have half a million Euros (or equivalent) in your portfolio.
  3. 3. You need sufficient knowledge by working or having worked in the financial sector for at least one year in a professional position, which requires knowledge of CFD & Forex trading.

You are never automatically given professional status, you would need to apply. Most brokers would have contacted the people whom they believe qualify for professional trader status, but even if you have not been contacted, you could still apply with your broker (or another).

Professional clients will have access to the full range of products available (including binary options with relevant providers), you will have access to the higher leverage and possible SOME negative balance protection.

Unlimited negative account balance protection will be unavailable and there will be modified ‘best execution rules’. Your broker will also communicate with you like a professional, so jargon and sophisticated language will be used as there will be an assumption that you are familiar with it, being a professional.

Your tax status will not change, you will still be responsible for declaring your earnings as you normally would.

RETAIL CLIENTS

The main benefit is the 100% negative account balance protection, but the retail clients are going to be hit with increased margin requirements and reduced leverage.

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Should I Become Professional?

Not necessarily.

It depends on whether your account is large enough to absorb the increased margin requirements for your style of trading. If it is, then perhaps you'd prefer the protection of keeping retail status. But I think that most people who are eligible to apply as a professional client will apply for professional client status.

You will lose FCSC and FOS protection and the broker won’t necessarily be on your side with the execution. Meaning that they will no longer prioritise cost as the most important factor when achieving the 'best execution'. But you will have access to higher leverage.

The interesting questions at the moment are 1. What about the UK brokers after Brexit - will they be bound by these regulations? 2. What about Australian, Swiss and Asian brokers, should I just move over to those guys?

At the moment, I do not have enough information to give the facts

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What About If My Broker Is Not In EU?

All the European union regulated brokers will be affected and have to comply with this regulations.

If your residence is outside of the EU, but your account is registered on the broker side with a broker who is regulated by the EU, then you will be affected by these changes. Your residence does not matter, it is all to do with where your account is registered.

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Which Index Markets Are Major?

The following equity indices are considered major indices:

All other indices are considered non-major.

Which Currencies Are Considered Major?

The major currencies are currency pairs made up of any two of the following currencies:

All other currencies are considered non-major.

Where Can I Find Extra Resources?

The ESMA website is a good place to start. Or trusted blogs.

https://www.esma.europa.eu/sites/default/files/library/esma35-36-1262_technical_qas_product_intervention.pdf

https://www.esma.europa.eu/sites/default/files/library/esma71-98-125_faq_esmas_product_intervention_measures.pdf

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CONTACT CHRIS WITH YOUR ENQUIRY

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Please provide some information below and Chris will contact you as soon as possible.

Tatnam Road, Poole, Dorset

Phone: 07912 682257

Email: info@daxtrader.co.uk


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