Leverage, spreads, regulations? Here’s what happened in 2016 and why you need to know

The year of 2016 has ended and continues to shape the retail FX and CFDs trading industry. December, especially, marks several key significances in regards to regulators, brokers, and the industry as a whole.

March 24, 2016: XTrade signs Cristiano Ronaldo to become official ambassador

Additionally, Usain Bolt becomes XM‘s official ambassador on November 14, 2016.

Why is this important?

The retail Forex and CFDs trading industry is becoming more and more competitive. Broker affiliations eventually trickle down to celebrity endorsement for increased exposure. Combine this with deposit bonuses, high leverage, fancy terms like ECN, STP, and NDD, and you have average Joes dreaming up riches.

June 30, 2016: Not all liquidity providers are created equal

Cypriot watchdog, CySEC, turns its sights on liquidity providers advising brokers to exercise “due skill, care, and diligence” when selecting every counterparty. Furthermore, CySEC advises brokers to avoid being over-reliant on just one liquidity provider.

This announcement was published in response to the Fortress Prime case. Brokers exercised a lack of due diligence in selecting the unregulated company registered in Dubai. Concerns for client funds arose when Fortress Prime went dark as they were unable to meet withdrawal requests.

Why is this important? 

For quite a while, the term “market maker” was almost treated as a bad word with retail traders believe the broker was out to get them. Market makers operate with a spread markup to earn their fees, but this doesn’t mean ECN brokers don’t have their drawbacks.

The flurry of retail traders have unreasonably swayed to the preference of ECN brokers. The lesson to be learned here is that it doesn’t hurt to pay a spread premium to use a trustworthy broker with deeper liquidity and ability to fill your orders consistently.

December had led to a string of events that have encouraged financial watchdogs to tighten up regulations in 2017.

December 6, 2016: FCA to ban all bonuses, proposes 50:1 leverage cap

The regulator states the growing number of companies offering Forex, CFDs, and Spread Betting is worrying because clients do not usually understand the risks of these products.

FCA proposes the following measures:

  • Brokers must disclose the profit-loss ratio of client accounts publicly
  • New clients with less than 12-months of experience are limited to using leverage no more than 25:1
  • All retail clients will be capped at a maximum of 50:1 leverage
  • Brokers must suspend all bonus practices

These guidelines serve to promote greater transparency and well capitalization in order to prevent excessive marginalized trading.

Why is this important?

Deposit bonuses and high leverage have long enticed new and inexperienced beginners to enter the market by promoting the ability to trade even with minimal capital. It’s not unheard of having beginners depositing $10 to $100 even to take in the thrill in this market. Unfortunately, the lack of experience and under-capitalization often leads to account wipeout.

Additionally, the majority of retail traders are losers and it’s important to make this emphasis. Finance Magnates used to publish U.S. Forex broker profitability reports, but seem to have seized doing so in recent years. It’s important to take the profit to loss ratio reports with a grain of salt because it doesn’t necessarily reflect a conflict of interest between the broker and trader.

Finally, the biggest complaint by far is the leverage reduction. Recall, U.S. traders suffered this reduction back in October, 2010 when the CFTC carried out a similar ruling.

If you interpret the two links together, you can see that Oanda has been long operating with a 50:1 leverage model and it has the highest profitable to losing ratio of 51% at one point. This indicates that it is indeed possible to operate profitably as a broker and trader with reduced leverage and market maker model.

Interesting Mentions

Shortly at FCA’s announcement of the proposed guidelines, shares of CMC Markets and IG Group lost almost half their value as the two brokers focus heavily on leveraged spread betting.

As of December 14, 2016, CMC Markets is currently contemplating job cuts and headquarters relocation amid the FCA crackdown. Brokers operating on offering high leverage in trading CFD derivatives are most at risk.

However, such a move makes absolutely perfect sense when it comes to protecting its clients interest especially in the even of another black swan event. The SNB unpeg of the Franc was an excellent example of how brokers treated negative balances and debt forgiveness. Exercising the conservative leverage offerings, Oanda was able to mitigate its own and client losses in the event of extreme volatility. Unsurprisingly, both CMC Markets and IG Group demanded clients to cover negative balance obligations in order to fulfill its own liquidity provider obligations.

December 27, 2016: IronFX withdrawal delays – $176m client money hole

CySEC and the ESMA began taking complaints filed against IronFX seriously in mid-2015 as submissions exceeded 1,000 without discounting duplicates. CySEC regulator noticed several operational concerns ranging from denying withdrawal requests to lack of segregation of bonus money and client funds. Full details presented in the linked article.

Why is this significant?

Not all regulators are created equally and CySEC certainly lacks the power over bigger firms in regards to how it mandates non-compliance. While every trader should exercise due diligence when it comes to selecting a reputable broker, this is a clear example of lack of regulatory power. The regulator, CySEC, demonstrates an inability to gain legitimacy.

screenshot-at-jan-03-00-50-13

If CySEC does not have restitution powers, then what good is it really? This article emphasizes the fact that not all regulators are created equally or, in this case, absolutely meaningless if they cannot take legal action in place of traders. It is crucial to find and choose a regulator that does more than just issues fines for its own revenues.

Trading in 2017:

Don’t let deposit bonuses, high leverage, and ECN execution cloud your judgement. It’s often safer to pay the spread/commission premium with a reputable broker than a new pop-up shop. If you really look into it, there’s only really a handful of brokers that have operated successfully for over 10 years.

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