New leverage rules: don’t get priced out of the markets

There’s a storm about to break over the heads of spread betters. And a lot of people are completely unaware of what’s brewing. I don’t want to sound alarmist, but for many of us, it’ll mean taking a completely new approach to the markets.

I’m talking about the new leverage rules from the ESMA, requiring traders to have significantly more margin in their accounts.

You may think that you’re a sensible trader, who doesn’t over stretch themselves … so, surely, you’ll be okay. Think again.

I expect you’ll be surprised at the effect this is going to have on your trading, and just how much money gets tied up in positions.

I’ve been crunching numbers on this for a few months, and figuring out the best approach to trading going forward. The reality is that you may have to kiss goodbye to some of your favourite trading methods. But the good news is that there is a ‘Goldlocks zone’ – where we can maximize the use of the money we do have in our account, avoid having to load more money into our accounts than we’re comfortable with – AND trade in a much safer environment.

Here I want to look at some examples of how your trades could be affected, and what you can do to help yourself. But I also want to tell you that I’m currently working with a professional trader who I’ve known and worked with for many years to create the perfect margin-busting trading method for you. (I hope to bring you all the details on this very soon, and well ahead of the new legislation coming in on the 1st August.)

The numbers: some examples of the effect it could have on your trades

First off, a reminder of what margin is. It’s not to be confused with the risk on your trade, but rather is the money your broker wants to see up-front before letting you take out a position.

Let’s say you’re buying the Wall St at 24225, with a stake of £2.

Currently your margin requirement would be around: £242

When the new requirements come in this summer, it’ll be: £2,422.50

Ouch!

And that £2,422.50 will be tied up in that trade, significantly affecting your ability to open further trades.

I don’t want to panic you – but it’s important to be aware that this shift is coming in, so we can prepare.

Why are they doing this to us?

Nanny state … directives from Brussels … we can grumble about these changes, but the thinking behind these it is to protect the many, many people who are duped into dodgy schemes, where they are hugely over-leveraged, with little understanding of the risks they are getting into.

But what about sensible investors, who are practicing good risk management already?

Well, we’re the ones who are going to have to adapt.

Fortunately, as traders – adapting to changing conditions should be something we’re very good at.

The solution

There are a few approaches to the problem, which I’ll look at here – and will be examining in more detail over the coming weeks.

The first is to throw money at it – if you can afford to load more cash into your spread bet account, then you’ll be fulfilling the requirements. However, I have a real issue with my money sitting in my broker’s account, when I’d much rather be using that money elsewhere.

The next suggestion is to go down the ‘professional investor’ route. You may have heard some chatter about this. To qualify as a professional, you need to meet 2 out of the following 3 criteria:

1. you have carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters;
2. the size of your financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds EUR 500,000;
3. you work or have worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged.

They are pretty stringent requirements, and a brokers who are lax about these rules could face very hefty penalties. I’ll be looking at this in more detail over the coming weeks.

The third solution is to adapt your trading style to suit. This means:

• Looking for cheaper products to trade
• Keeping staking levels low
• Restricting time in the market, so money isn’t tied up in margin for long periods.

And this is where we have to find the sweet spot. To explain this, I’d like to look first at how we usually manage risk in our trades …

Managing risk with stop losses

Of course, all well-trained spread betters know to use a stop loss to manage their risk. So, even if you’ve bought into an expensive market, like Wall St, you’re not actually risking the value of Wall St falling to zero.

For years, many brokers have used something called ‘order-aware margin’ – this means that the margin require is adjusted according to your stop distance. So, if you’re risking £500 on a trade, you’ll need a bigger margin that if you’re risking £10.

Unfortunately, this avenue is also being closed off to traders. To me, this is the most frustrating aspect of these changes. It’s a grey area, and it’s possible that some brokers will continue to use it – if they do, I’ll definitely be giving you some ideas of how to take advantage of it.

But, that doesn’t mean that your stop distance isn’t very important.

Let’s look at some more examples …

Here we’re looking at two traders who are placing trades on GBPUSD at 13050. Both traders are looking to make £100 profit from their trades, and both are prepared to risk a maximum of £100. Major FX will have a new margin requirement of 3.33% – so, for each £1 we stake, we’ll be tying up £434.57 in margin.

Trader A is a scalper. He’s looking for 5 points profit, and sets his stop level 5 points below his entry. He’s looking to risk no more than £100, so will be staking £20 per point. So, Trader A’s margin requirement will be £434.57 x £20 = £8,692

Now let’s look at Trader B. He’s looking to hold his position over a longer period. His profit target is 100 points above his entry, and his stop is 100 below his entry. Again, he’s risking just £100 per trade, so will be using a £1 stake. Therefore, Trader B’s margin requirement will be just £434.57

It would be easy to look at this and think that the solution is to go for long-term trades with wide stops and low stakes … but the downside of that comes with tying up money for long periods, waiting for those profits to come in.

And that’s where we have to find the sweet spot – balancing time in the market against profits available. That way, we’re able to be nimble, picking up available profits, then closing out trades so we can use that margin money again and again.

Putting it all together

If this information about margin requirements has left your head spinning – please don’t worry.

I’m busy working right now on clear, precise trading plans that’ll get you through August 1st trading without any nasty surprises.
 
If you’d like help calculating new margin requirements, please check out my margin calculator here.
 

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