In 2018, the European Securities and Markets Authority (ESMA) put limits on the opening of contracts for difference (CFD) positions by a retail client from 30:1 to 2:1, varying according to the volatility of the underlying asset.
The Financial Conduct Authority (FCA) in the United Kingdom followed suit in 2020 limiting leverage to similar boundaries.
In the following year, the Australian Securities and Investments Commission (ASIC) announced similar limits.
Why? Evidence from their respective inquiries showed excessive leverage was behind significant losses to retail clients.
The outcome of these interventions proved these measures were necessary. A good example is Australia where there was over a 90 per cent reduction in aggregate net losses by retail client accounts.
Plus loss-making retail client accounts were reduced by over 50 per cent per quarter on average. That notwithstanding, these efforts can only do so much to curb irresponsible trading.
Individual responsibility is still central to achieving any measure of success.
But we need to start from somewhere. A similar inquiry that leads to some form of leverage curbs will be overall beneficial.
Why? It’s almost certain that when these big jurisdictions intervened in their markets, the problem simply shifted elsewhere.
Likely destinations for players who don’t favour such restrictions are now only two: Africa and Latin America - remember CFDs are banned in the United States.
With trader results staying largely the same - over 85 per cent losing their monies trading CFDs - there's every reason why some form of intervention is needed in the local market.
But even if this were to happen, it would still not be enough. Traders are most likely to move their accounts elsewhere where excessive leverage is allowed as witnessed in the named jurisdictions.
This points to one conclusion - a good education is lacking. I submit that most clients have no clue about what they are doing and have no business trading at all.
With scanty information, many are wooed in by false advertising pushing a “fast money” narrative or a “trading for a living” nirvana.
I often wonder how a two- or three-day seminar can turn an inexperienced newbie into a perceptive trader buying and selling in quick-shifting markets.
Besides, I find it irritating that many industry salesmen can’t, won’t and don't know how to trade. But I can tolerate that stance because the stats speak for themselves.
Since the introduction of CFDs in the early 90s, there’s never been (I doubt they’ll ever be) anyone who’s become even moderately successful trading CFDs.
The industry can no longer hide behind the veil of “democratising global markets'' while offering inadequate preparation to would-be traders.
Demo accounts are no defence. But since no broker holds a gun to your head to maximise your leverage or copy trade, the burden to learn lies on you. It’s your money at risk.
Consider this; if the very best of traders barely go beyond 2:1, what makes you think you’ll succeed with a 100:1 leverage?
Take this wise saying and learn from it; “If the axe is dull and its edge unsharpened, more strength is needed, but skill will bring success. And if you find honey (read leverage), eat just enough-- too much of it, and you will vomit.”
The writer is the MD of Canaan Capital.
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