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?
How Much Should I Risk Trading Forex? | Trading Forex
New traders are often surprised to learn that when it comes to becoming profitable over the long term, controlling risk is just as important as making good trades. Risk, position sizing, and money management are no less important than trade entry and exit strategies, and should all be considered scientifically and thoroughly. If you get them right, then as long as you can maintain a trading edge (which is not very hard, as there are a few well documented trading edges), you have a solid blueprint for making a lot of money. You don’t need to pick spectacular trades to make a lot of money, you just need to keep consistently doing the right thing, and let the magic of compounded money management snowball the growth of your account equity. To get it right, start by asking a few basic questions.
How Much Money Should I Put in my Trading Account?
You have opened an account with a broker, and you are ready to start trading. You just need to deposit some cash. How much should you put in? You must be honest with yourself, and consider how much cash you have which is available for building wealth. You should not include assets such as a house or car in that calculation, or pensions: the question is how much free cash can you get your hands on, without debt, and use to try to increase your wealth? Once you have this number, you should be prepared to place no more than 10% or maybe 15% of it into something risky, like trading Forex. This might seem like a very small amount, but it really isn’t – please read on and I will explain why.The Risk “Barbell”
Imagine there are two traders, Trader A and Trader B. Both have $10,000 in liquid assets, which is all the ready cash each of them can get their hands on and use to build wealth. After opening brokerage accounts, Trader A funds his with his entire $10,000 while Trader B funds hers with 10% of the same amount, $1,000, while placing the remaining $9,000 in treasury bills guaranteed by the United States, which pay a low rate of interest.Consider their respective positions. Trader A will be at a psychological disadvantage, as the account represents all the money he has, so losses will probably be painful for him. He should also worry about the broker going bankrupt and not being able to get any of his funds back, unless the broker is backed by a government deposit insurance program. Even then, his money could be tied up for more than one year before he gets any insurance. Due to his fears, even though he knows the best risk per trade for his trading strategy is 2% of his account equity per trade (more on how to calculate that later), he decides to risk less than this. He decides to risk only one-tenth of the full amount, so will risk 0.2% of his equity on each trade.
Trader B feels much more relaxed than Trader A. She has $9,000 very safely parked in U.S. Treasury Bills, and has $1,000 in her new brokerage account. Even if she loses the entire account, at the end she would only have lost 10% of her investible wealth, which would not be fatal and could be recovered. It is drawdowns exceeding 20% that are a challenge to recover from. Trader B is more psychologically prepared for risk than Trader A is. She calculates that the optimal risk per trade for her trading strategy is 2% of her account equity per trade, just like Trader A, but unlike Trader A, she is going to risk that full amount.
Both Trader A and Trader B are going to begin by risking the same amount per trade in cash, $20. Below is a graph showing how their account equities will grow if they each follow their money management plan and win 40 consecutive trades (which is very unlikely to happen in real life):
Account Growth – Trader A Vs. Trader B
Trader B, with the smaller $1,000 account and the $9,000 in T-bills, ends up with a total profit of $811, of which $117 is interest received at the end of the year on the T-bills. Trader A, with the larger $10,000, ends up with a total profit of $617. Even though they start with the same risk, diversifying risk capital between conservative fixed income and something much riskier, pays Trader B a significant benefit, and gives her the peace of mind to be as aggressive with risk as she should be.
How Much Money Should I Risk Per Trade?
This is an easy question to answer, if you know the average or median amount of profit you can reasonably expect to make on each trade, and you are concerned only with maximizing your total long-term profit: use a fixed fractional money management system based upon the Kelly Criteria (a formula which will be explained in detail in the next paragraph). A fixed fractional system risks the same percentage of your account value on each trade, as we showed in the earlier example of Traders A and B who were using 0.2% and 2%. Fixed fractional money management has two big advantages over other strategies. Firstly, you risk less during losing streaks, and more during winning streaks, when the effect of compounding really helps build up the account. Secondly, it is theoretically impossible to lose your entire account, as you are always risking X% of what is left, and never all of it.The final question is, how do you calculate the size of the fraction to risk? The Kelly Criteria is a formula that was developed to show the maximum amount which could be risked on a trade and would maximize long-term profit. If you know your approximate odds on each trade, you can easily calculate the optimal amount using a Kelly Criteria calculator. In good Forex trading strategies, the amount suggested by the Kelly formula is typically between 2% and 4% of account equity.
A word of warning: using the full amount suggested by Kelly is bound to lead to huge drawdowns after losing streaks. Some fine traders, notably Ed Thorp, have suggested using half the amount suggested by a Kelly Criteria calculator. This generates 75% of the long-term profit, but only 50% of the drawdown, produced by the full Kelly Criteria.
Money Management is Part of the “Holy Grail”
It is no exaggeration to say that the major reason why traders still fail even when they are following the trend and getting their entries and exits mostly right, is because they are not following the risk and money management techniques set out here in this article, as part of a comprehensive trading plan. Forget about the result of the trade you take today, and worry instead about the overall results of the next 200, 500, or 1000 trades you take instead. If you can make a profit of only 20% of your risk on average per trade, which is feasible using a trend-following volatility breakout strategy, it is quite possible to turn a few hundred into a million within ten years.Source
How Much Should I Risk Trading Forex? | Trading Forex
New traders are often surprised to learn that when it comes to becoming profitable over the long term, controlling risk is just as important as making good trades. Risk, position sizing, and money management are no less important than trade entry and exit strategies, and should all be considered scientifically and thoroughly. If you get them right, then as long as you can maintain a trading edge (which is not very hard, as there are a few well documented trading edges), you have a solid blueprint for making a lot of money. You don’t need to pick spectacular trades to make a lot of money, you just need to keep consistently doing the right thing, and let the magic of compounded money management snowball the growth of your account equity. To get it right, start by asking a few basic questions.
How Much Money Should I Put in my Trading Account?
You have opened an account with a broker, and you are ready to start trading. You just need to deposit some cash. How much should you put in? You must be honest with yourself, and consider how much cash you have which is available for building wealth. You should not include assets such as a house or car in that calculation, or pensions: the question is how much free cash can you get your hands on, without debt, and use to try to increase your wealth? Once you have this number, you should be prepared to place no more than 10% or maybe 15% of it into something risky, like trading Forex. This might seem like a very small amount, but it really isn’t – please read on and I will explain why.The Risk “Barbell”
Imagine there are two traders, Trader A and Trader B. Both have $10,000 in liquid assets, which is all the ready cash each of them can get their hands on and use to build wealth. After opening brokerage accounts, Trader A funds his with his entire $10,000 while Trader B funds hers with 10% of the same amount, $1,000, while placing the remaining $9,000 in treasury bills guaranteed by the United States, which pay a low rate of interest.Consider their respective positions. Trader A will be at a psychological disadvantage, as the account represents all the money he has, so losses will probably be painful for him. He should also worry about the broker going bankrupt and not being able to get any of his funds back, unless the broker is backed by a government deposit insurance program. Even then, his money could be tied up for more than one year before he gets any insurance. Due to his fears, even though he knows the best risk per trade for his trading strategy is 2% of his account equity per trade (more on how to calculate that later), he decides to risk less than this. He decides to risk only one-tenth of the full amount, so will risk 0.2% of his equity on each trade.
Trader B feels much more relaxed than Trader A. She has $9,000 very safely parked in U.S. Treasury Bills, and has $1,000 in her new brokerage account. Even if she loses the entire account, at the end she would only have lost 10% of her investible wealth, which would not be fatal and could be recovered. It is drawdowns exceeding 20% that are a challenge to recover from. Trader B is more psychologically prepared for risk than Trader A is. She calculates that the optimal risk per trade for her trading strategy is 2% of her account equity per trade, just like Trader A, but unlike Trader A, she is going to risk that full amount.
Both Trader A and Trader B are going to begin by risking the same amount per trade in cash, $20. Below is a graph showing how their account equities will grow if they each follow their money management plan and win 40 consecutive trades (which is very unlikely to happen in real life):
Account Growth – Trader A Vs. Trader B
Trader B, with the smaller $1,000 account and the $9,000 in T-bills, ends up with a total profit of $811, of which $117 is interest received at the end of the year on the T-bills. Trader A, with the larger $10,000, ends up with a total profit of $617. Even though they start with the same risk, diversifying risk capital between conservative fixed income and something much riskier, pays Trader B a significant benefit, and gives her the peace of mind to be as aggressive with risk as she should be.
How Much Money Should I Risk Per Trade?
This is an easy question to answer, if you know the average or median amount of profit you can reasonably expect to make on each trade, and you are concerned only with maximizing your total long-term profit: use a fixed fractional money management system based upon the Kelly Criteria (a formula which will be explained in detail in the next paragraph). A fixed fractional system risks the same percentage of your account value on each trade, as we showed in the earlier example of Traders A and B who were using 0.2% and 2%. Fixed fractional money management has two big advantages over other strategies. Firstly, you risk less during losing streaks, and more during winning streaks, when the effect of compounding really helps build up the account. Secondly, it is theoretically impossible to lose your entire account, as you are always risking X% of what is left, and never all of it.The final question is, how do you calculate the size of the fraction to risk? The Kelly Criteria is a formula that was developed to show the maximum amount which could be risked on a trade and would maximize long-term profit. If you know your approximate odds on each trade, you can easily calculate the optimal amount using a Kelly Criteria calculator. In good Forex trading strategies, the amount suggested by the Kelly formula is typically between 2% and 4% of account equity.
A word of warning: using the full amount suggested by Kelly is bound to lead to huge drawdowns after losing streaks. Some fine traders, notably Ed Thorp, have suggested using half the amount suggested by a Kelly Criteria calculator. This generates 75% of the long-term profit, but only 50% of the drawdown, produced by the full Kelly Criteria.
Money Management is Part of the “Holy Grail”
It is no exaggeration to say that the major reason why traders still fail even when they are following the trend and getting their entries and exits mostly right, is because they are not following the risk and money management techniques set out here in this article, as part of a comprehensive trading plan. Forget about the result of the trade you take today, and worry instead about the overall results of the next 200, 500, or 1000 trades you take instead. If you can make a profit of only 20% of your risk on average per trade, which is feasible using a trend-following volatility breakout strategy, it is quite possible to turn a few hundred into a million within ten years.Source
How Much Should I Risk Trading Forex? | Trading Forex
New traders are often surprised to learn that when it comes to becoming profitable over the long term, controlling risk is just as important as making good trades. Risk, position sizing, and money management are no less important than trade entry and exit strategies, and should all be considered scientifically and thoroughly. If you get them right, then as long as you can maintain a trading edge (which is not very hard, as there are a few well documented trading edges), you have a solid blueprint for making a lot of money. You don’t need to pick spectacular trades to make a lot of money, you just need to keep consistently doing the right thing, and let the magic of compounded money management snowball the growth of your account equity. To get it right, start by asking a few basic questions.
How Much Money Should I Put in my Trading Account?
You have opened an account with a broker, and you are ready to start trading. You just need to deposit some cash. How much should you put in? You must be honest with yourself, and consider how much cash you have which is available for building wealth. You should not include assets such as a house or car in that calculation, or pensions: the question is how much free cash can you get your hands on, without debt, and use to try to increase your wealth? Once you have this number, you should be prepared to place no more than 10% or maybe 15% of it into something risky, like trading Forex. This might seem like a very small amount, but it really isn’t – please read on and I will explain why.The Risk “Barbell”
Imagine there are two traders, Trader A and Trader B. Both have $10,000 in liquid assets, which is all the ready cash each of them can get their hands on and use to build wealth. After opening brokerage accounts, Trader A funds his with his entire $10,000 while Trader B funds hers with 10% of the same amount, $1,000, while placing the remaining $9,000 in treasury bills guaranteed by the United States, which pay a low rate of interest.Consider their respective positions. Trader A will be at a psychological disadvantage, as the account represents all the money he has, so losses will probably be painful for him. He should also worry about the broker going bankrupt and not being able to get any of his funds back, unless the broker is backed by a government deposit insurance program. Even then, his money could be tied up for more than one year before he gets any insurance. Due to his fears, even though he knows the best risk per trade for his trading strategy is 2% of his account equity per trade (more on how to calculate that later), he decides to risk less than this. He decides to risk only one-tenth of the full amount, so will risk 0.2% of his equity on each trade.
Trader B feels much more relaxed than Trader A. She has $9,000 very safely parked in U.S. Treasury Bills, and has $1,000 in her new brokerage account. Even if she loses the entire account, at the end she would only have lost 10% of her investible wealth, which would not be fatal and could be recovered. It is drawdowns exceeding 20% that are a challenge to recover from. Trader B is more psychologically prepared for risk than Trader A is. She calculates that the optimal risk per trade for her trading strategy is 2% of her account equity per trade, just like Trader A, but unlike Trader A, she is going to risk that full amount.
Both Trader A and Trader B are going to begin by risking the same amount per trade in cash, $20. Below is a graph showing how their account equities will grow if they each follow their money management plan and win 40 consecutive trades (which is very unlikely to happen in real life):
Account Growth – Trader A Vs. Trader B
Trader B, with the smaller $1,000 account and the $9,000 in T-bills, ends up with a total profit of $811, of which $117 is interest received at the end of the year on the T-bills. Trader A, with the larger $10,000, ends up with a total profit of $617. Even though they start with the same risk, diversifying risk capital between conservative fixed income and something much riskier, pays Trader B a significant benefit, and gives her the peace of mind to be as aggressive with risk as she should be.
How Much Money Should I Risk Per Trade?
This is an easy question to answer, if you know the average or median amount of profit you can reasonably expect to make on each trade, and you are concerned only with maximizing your total long-term profit: use a fixed fractional money management system based upon the Kelly Criteria (a formula which will be explained in detail in the next paragraph). A fixed fractional system risks the same percentage of your account value on each trade, as we showed in the earlier example of Traders A and B who were using 0.2% and 2%. Fixed fractional money management has two big advantages over other strategies. Firstly, you risk less during losing streaks, and more during winning streaks, when the effect of compounding really helps build up the account. Secondly, it is theoretically impossible to lose your entire account, as you are always risking X% of what is left, and never all of it.The final question is, how do you calculate the size of the fraction to risk? The Kelly Criteria is a formula that was developed to show the maximum amount which could be risked on a trade and would maximize long-term profit. If you know your approximate odds on each trade, you can easily calculate the optimal amount using a Kelly Criteria calculator. In good Forex trading strategies, the amount suggested by the Kelly formula is typically between 2% and 4% of account equity.
A word of warning: using the full amount suggested by Kelly is bound to lead to huge drawdowns after losing streaks. Some fine traders, notably Ed Thorp, have suggested using half the amount suggested by a Kelly Criteria calculator. This generates 75% of the long-term profit, but only 50% of the drawdown, produced by the full Kelly Criteria.
Money Management is Part of the “Holy Grail”
It is no exaggeration to say that the major reason why traders still fail even when they are following the trend and getting their entries and exits mostly right, is because they are not following the risk and money management techniques set out here in this article, as part of a comprehensive trading plan. Forget about the result of the trade you take today, and worry instead about the overall results of the next 200, 500, or 1000 trades you take instead. If you can make a profit of only 20% of your risk on average per trade, which is feasible using a trend-following volatility breakout strategy, it is quite possible to turn a few hundred into a million within ten years.Source
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