This article references the changes to leverage and restrictions to CFD products in Forex, Crypto, Indices and more. In particular, we refer to “20-254MR ASIC product intervention order strengthens CFD protections“. To cover the main points and how it might effect traders and the brokers.
The legislation in reference refers to changes to the leverage and a few other major changes in the CFD brokerage industry.
Changes to Leverage
Leverage is a way of saying how much Margin is required to place your orders. A highly leveraged account of 1:500 means you can trade the contract for 500 times less than if it were 1:1. So instead of entering a CFD for $500 it might only need $1 of margin.
Firstly, let us explain the leverage side of things and what these new changes mean for traders. Leverage is simply the term used to say how much more money are you able to use, compared to each dollar you put in. This effects how much margin you need, in order to place your trade.
So if the leverage is 1:100 then your contract might require $100 to be in margin. This is the price of holding a position (but not a cost). So if you have $200 in your account, you need $100 of that to hold this position and that means there is $100 of Free Margin in the account which will fluctuate depending on your profit and loss of the trade.
Changing the leverage will effect how much margin is required to hold each position. Of course this will vary based on the volume used. To hold a position now, let’s say it requires $100 to hold at 1:100, the new leverage of 1:30 will mean to hold that same position, you will need a little over $300 to hold the same position.
The Effect on Your Trades
There is no change to how that instrument/symbol fluctuates or moves (unless people stop trading because of these changes), so everything will be the same however it will just require a lot more money to be involved in the same sized positions.
Positions will require more ‘margin’ and this means that you either need to have say 3 times the account size to do what you were, or reduce your volume when you place orders. Either way, this will require more money to get the same result or you will simply be trading at lower volume, meaning lower risk.
If you trade within a reasonable risk tolerance, these changes will probably not have any effect at all. The margin used on these accounts will likely only effect people that only want to trade with the minimum amounts in their account or the people that over risk their account.
Who is effected?
Let’s look at who will be effected… People looking to go for big wins without much upfront capital and people that do not want to have to much in their account. Also, anyone that is trading too much risk compared with their account balance.
Using the leverage to its maximum potential signifies that high risk is being used. While this is probably a good thing for people experimenting with the platform, volume and trading in general, these people should not be trading live until they can pass a more rigorous test.
Trading is often given a bad name due to dodgy brokers and promoters overselling the potential, and people not getting enough experience before diving head first into murky water. A better ruling would be to restrict live account access until proper understanding around leverage and potential losses can be understood.
Strange Global Tightening
These rules demonstrate that it will soon be much harder to trade in a sense that you will need much more capital to have the same impact on your account. It is almost as though these rules are being restricted to stop or slow the likelihood of up and comers with not much money, a way out and a way to make money without already being wealthy. A much higher barrier to entry to earn decent returns will push a lot of players out of the game.
The restrictions are not just in Australia, but are being introduced in a similar way across the EU. Not to mention the restrictions already in USA which makes it difficult to trade CFD’s. Is this a way to limit the ‘non-wealthy’ from a slice of the pie, or is it trying to stop people without the right knowledge and experience entering something that they might just lose all their money.
Alternate Effects On Traders
Let us now take a look at what the other effects on traders might be. When leverage changes, it effects the margin required to enter trades which was discussed earlier. There is more to it than this, so we can dive a little deeper into trading psychology.
As traders now need more money in the account to do what they did before, this may influence people to put more money in so that they can facilitate the trades they want to do. This means bigger deposits for the same effect, and while the leverage is less, the loss could end up being much higher overall in terms of actual money put into the account and potentially drained. If someone wanted to only use $1000 to trade with, but now have to put in $3000 for the same effect, there is a chance that rather than using $1000 over time in trading losses, this could now become $3000 instead. While they may wish to only lose $1000 overall if that happens, their trading psychology may influence them to keep going and end up losing 3 times what they would have compared to the higher leveraged accounts.
Other Investment Alternatives
After investigating most investment opportunities available, CFD’s offered the highest leverage with the lowest costs to enter positions. They also had some of the easiest platforms and access to use this type of investment through plenty of brokers. With the new rules de-leveraging CFD’s, the effect on other investments may now become a little more attractive.
After spending time comparing CFD’s and Options as an investment opportunity, CFD’s seemed to be the easier and less costly option for what was very much a similar result in terms of profit/loss outcomes. With the changes being imposed on CFD’s, this might change.
Options are a great way to gain exposure and to be able to hold a position for longer and gain about the same exposure that you might with a CFD. The downside is, they are a little more complex, have different time periods and have higher fees. One good thing about options is even when price goes massively against you, you have already set your maximum loss. Comapred to CFD’s where the loss can simply keep getting bigger, you pay your max loss upfront. This makes options more stress free while also enjoying the potential upside you get with CFD’s.
A Possible Shift
The changes to the regulations in leverage may create a shift away from trading CFD’s altogether. It may cause people to look elsewhere for investing their money, such as options, or perhaps more traditional investments such as shares and property.
The other change that may have an even more negative spin, is that unregulated brokers may have the upper hand in terms of what they can offer. Higher leverage, rebates and more could be enough to entice unsuspecting victims into having their money taken from them. While trading with unknown brokers is always scary, with little to defend yourself once you send the money across, these new laws may be enough to create an en mass search for higher leverage brokers that are not under the strict rules of the EU and AU requirements. This could be the greatest risk of all.
Understanding ASIC's Why
ASIC have made this decision for a reason. Client losses were detailed as being over 700 million during the COVID crash in 2020. They idea is that reducing leverage will in turn reduce the losses, particularly in highly volatile periods. The other benefit is a reduced potential for negative balances.
Unfortunately most traders do not succeed in making a profit when trading the financial markets over the long term. This is often due to a lack of knowledge and experience initially, then often continues by way of psychology and risk appetite needing an extreme level of work to reach a goal.
While reducing the leverage is one way, they have also brought in heavier restrictions on rebates, gifts and trading credits. This could be a good move to help reduce any shady dealings that brokers are doing to draw in people that are not ready to trade. But a blanket approach cutting out anyone that might have been working towards something more through trading, this ruling may be a bit of a speed bump. For now, there’s a few options that could work, but it just depends on who is affected. Potentially, the funded account programs may not be an issue, such as FTMO as their risk management etc. would be within the leverage requirements anyway.