Leverage - The New ESMA Proposals - What Will Less Leverage Mean For Retail Traders?

Reading Time - 8 Minutes

It is one of the words that every trader has come across at some point. However, very few actually understand what it is or how it works. In this blog post I am going to look at specifically the new rules on leverage proposed by ESMA (European Securities and Markets Authority). We will look at the differences the changes will make and also show who it will hit hardest.

I am sure if you are with a broker anywhere in Europe, you have received somewhat panic-stricken emails from the broker, urging you to email ESMA and show your opposition to the new leverage restrictions they are suggesting. Your broker isn’t doing that because they care about you and want you to always have the best they can offer – they are emailing you because the new regulations would cost the brokers money in loss of business.

So, the first thing to say is that I would be VERY surprised if the new regulations don’t come into force. The EU write their own rules with very little care for the opinion outside of their bureaucracy. Sometimes I think their departments make new regulations simply to justify their jobs… can you spot my disdain for them yet?

However, there does need to be a change within the trading industry. You can get leverage as high as 1:200, which is frankly ridiculous. What it does is inspire gambling and leads to a lot of beginners losing a lot of money. It is easy to quick-fire orders on a market when you are in a downward spiral of emotional trading, and with such high leverage, your broker will only margin call your account when it is almost completely cleaned out. 

The brokers themselves do not care, and so it had to come to some regulatory board to bring about changes. I do think as an adult, you should shoulder the full responsibility of your decisions and be able to MAKE those decisions without big-brother looking over your shoulder. You risked the money. You lost the money. It is your own fault. But the changes are almost certainly coming, and there will actually be some benefits and safeguards that it will bring about.

So, who is this going to hurt and who isn’t it going to hurt?

Mainly it is going to hurt those with small trading accounts. It is going to force you to reduce your risk on trades, like it or not. It may even price some people out of the markets… But, is that a bad thing? If you are risking extremely high amounts in terms of a percentage of your overall account, you are going to blow your account anyway. It happens every single time. If you are looking to build a career or a serious secondary income source, you need to use strict money management. The new leverage rules will force you to be somewhat safer with your money.

What about those who can’t afford to open an account and trade with the new leverage levels? Again, is that really that bad? If you can’t afford to put say a couple of thousand in an account, should you even be trading? People may get outraged but being able to trade at 1:200 is crazy. It will force people onto a demo account until they can build money enough to open a live account. In that time, people can learn whilst safe from blowing a real account.

It is also going to hurt swing traders or anyone who has multiple positions open at once. Trying to hold 5 – 10 positions at once will require a much larger account to cover the margin requirements. We are going to look at some examples shortly.

Who isn’t it going to hurt as much? Well, us day traders who use good money-management. If you are risking small amounts of your capital, say 1% - 3% then the new leverage will not have such a profound impact. As a day trader, I only ever have 1 position open at a time, and on very rare occasions, two. Again, that protects me from the new changes. But really, it protects me from huge losses, which is the real reason I do it, and the real reason all professionals do it.

Let’s look at a couple of examples on the FTSE 100 and EURUSD using IG Index broker. Currently, they offer up to 1:200 leverage. However, with the new proposals, major markets may drop down to 1:30.

The amounts we will use can be reduced slightly by using tight stops, but for the purpose of this blog we will just use the standard margin requirements for the positions.

FTSE 100 EXAMPLES

Let’s look at two FTSE 100 examples. We will say you want to open a position risking £10 per point (spread betting) or one contract (CFD). For our second example we will look at a position risking £2 per point (spread betting) or one mini-contract (CFD).

The simplified sum we use is:

Risk X Current Market Level X Margin Factor 

So for the FTSE 100 examples:

10 X 7220 (around the current level on 20^th Feb) X 0.9% (Your broker will display their margin factor for each market)

= £649.80

That is what needs to be in your account to cover the trade – basically it is what your broker uses as a deposit to secure the use of the leverage. If you took another trade at the exact same level with the same risk, you would then need £1,299.60 etc.

Our second example would be:

2 X 7220 X 0.9% = £129.96

It is important to note here also, that these totals are not your risk when calculating say your 1% risk for entering a trade. Just because my margin is £129.96, does not mean that I am not planning on exiting at a minus £40 loss, which would be a 1% risk on a £4,000 account. If my stop is set at the £40 loss level, my risk is £40, not the margin amount.

Now let’s do the math on the same position on EUR/USD which has a margin factor of 0.45%

 EURUSD EXAMPLES

10 X 13,345 (around the current level on 20^th Feb) X 0.45% = £600.53

2 X 13,345 X 0.45% = £120.10

So, what we can see, is that currently you really don’t need a lot of money to open positions. But what most people see is the ability to make much larger returns in terms of their investment. The other side of the coin is that the losses can also happen very quickly. You can be risking huge portions of your account on trades and within a matter of minutes be left with nothing. The gambling warnings that every broker displays are not there randomly. They are there because a very high portion of people gamble their money away very very quickly in trading.

Let’s now look at the same examples, but with a new 1:30 leverage limit that is likely going to come into force. That will equate to roughly 3.33%.

FTSE 100 EXAMPLES

10 X 7220 X 3.33% = £2,404.26

2 X 7220 X 3.33% = £480.52

So, now we have much bigger numbers. But, as long as you are following good money management, the changes really shouldn’t scare you at all. Especially not if you are a day trader. What it will also do, is FORCE people to use much better money management and keep people who can’t afford to lose the money off of the charts. I must stress here, I in NO WAY agree with the changes and think adults should make their own free choices. However, you have to take into account the positives. If you had heard as many horror stories as I have of people losing their pensions and life-savings, you would understand where I am coming from. Sometimes safety nets DO help.

If we look at the widely accepted ‘safe’ level of money management, it suggests only ever risking 1% of your account on any one trade. 

Now let’s say at £10 per point on the FTSE 100 you are risking 12 points – which is an average sized stop for me day trading. We will also use this example for the £2 per point risk.

That means you are risking £120, which means you should have a £12,000 account. For the second example you are risking £24 and should have a £2,400 account.

As you can see, neither of these are hampered by the new leverage proposals. You would need to either be in 5 trades at once, or risking way too high in proportion to your trading account for it to start impacting you. This is where it may hurt swing traders. If you usually have 5 – 10 positions open at once, that is going to become very difficult to do without reducing risk drastically.

For EURUSD, using the same examples but with a similar 12-point stop – 

EURUSD EXAMPLES

10 X 13,345 X 3.33% = £4,443.89

2 X 13,345 X 3.33% = £888.78

Your risk is exactly the same in both examples, and again the new leverage regulations do not hamper your trading. Even after multiple losses in a row, you STILL have the ability to trade at your 1% risk without adjustments. Even if you are risking 2% per trade, it does not hurt your trading approach.

So, the likelihood is that the new leverage regulations WILL come into force. I do not in any way expect the emails of us retail traders to change the proposals. However, it isn’t something you should fear as a trader on the worry that it will snuff you out of doing something you enjoy. For us day traders certainly, and those using good money management, we will be able to continue as normal. It will also force beginners to use better money management which is no bad thing.

I hope you’ve all had a great trading week!

Compounding - The Tortoise and the Hare - The True Secret of Trading Success

Reading Time - 7 Minutes

 

Have you ever heard the story about the Tortoise and the Hare? I am sure you have. But what you probably didn’t realise is that the story can be linked to trading. In fact, the Tortoise and the Hare is pretty much how I would categorise the successful Trader (the Tortoise) and those who never seem to get anywhere (the Hare).

In this blog post we are going to look at compounding. I am going to explain to you how it works, and beat the marching drum for it, in the hope that some of you fall into the slow march.

There are two categories of Traders out there. We have the get rich quick, fast cash brigade first. This is the Hare. This person wants to become a Trader and they want to become a millionaire and watch their account swell. They want it NOW. Sadly, this is the predominant type of person learning to trade. There are thousands of websites

that cater to them, promising ‘secret strategies’ and ‘financial freedom’ and ‘fast results.’ This type of trader has wild swings on their account. Sometimes they DO make large amounts of cash. But they lose it just as fast. They spend months and oftentimes years banging their head against the wall of Fast Cash and continue to make the same mistakes over and over again. Sadly, the result is always that eventually, they are forced to stop trading. They either lose too much money and can’t afford to continue, or their body has taken such an emotional beating that they are forced to retreat.

Whereas the Hare lost his race by being cocky and taking a nap, the Fast Cash Trader loses because instead of going at a sustainable pace, they try to go faster and faster until their heart gives out and they keel over. The answer to problems for the Fast Cash Trader is to increase risk, to trade more, and to attack markets until they get what they want.

They don’t understand one of the REAL secrets of trading – which is compounding. Instead, they want to make 100% per month. They want to make this amount because they need to make this much so they can live off of their trading income. Remember, they want to do that NOW. They need to make a certain amount each week for their wage. There is no future planning, they just want the money. If only someone could show them that by demanding the Fast Cash, they are instead making it impossible to succeed.

Now let’s look at the Tortoise. This Trader isn’t particularly exciting. They think in terms of years, rather than short term. This Trader understands that by taking a long-term view, and by allowing one of the true secrets of trading to work its magic, they can achieve their trading goals.

To understand compounding, I’ll tell you a quick story I was told when I was a teenager. My Dad told me a story about a man who went to play a game of golf. The person he was playing against said, to keep this interesting, let’s bet some money on each hole. We will start with £1 and double the risk each hole we play.

Now, that sounds absolutely fine, doesn’t it?  A friendly game of golf with some risk between friends. But how much do you suppose they would be risking by the 18^th hole?

By the 18^th hole, they would be risking over £131,000.

And that, is the magic of compounding.

Now, I was around seventeen at the time. So, in all honesty, it blew right over my head. I was more interested in what my friends were doing at the weekend and what house party we were all going to so I could try my best to chase girls (and fail miserably as always).

But, once I found Trading, I understood the real power behind compounding.

It is IMPOSSIBLE to sustain huge Trading returns. I did a video about this on the YouTube channel called – The Most Common Trading Scam I see and the Number One Reason Beginner Traders Fail. I am not going to touch too much on it here. But rest assured, if these idiots promising even 50% returns per month could be believed, you would be the richest person in the world in a couple of years starting with only a modest account. It just isn’t possible. Sorry to burst your bubble, but if it were, banks and hedge funds with multi-billion pounds of spending power would be doing it, not some idiot sitting in his bedroom on his laptop. Instead, you’ll be back to being the Hare – running really fast and going exactly nowhere, over and over again.

But we are interested in the Tortoise. And it is important because it can help you take a HUGE amount of stress off of your shoulders as you learn and start to find consistency. By putting an arm around the shoulders of compounding and by accepting trading as a long-term venture, you can achieve your goals.

Let’s say you are at the stage whereby you are finding consistency as a Trader (If you’re not there, then that is fine also. You are still in the learning phase. Just take your time and protect your capital. The compounding can come after you learn. Crawl first, then walk). Now, when you start to become consistent, the danger is there that you suddenly ‘want to be a Trader’. And by saying that, I mean you want to quit your job and live life on a beach. The problem is, to do that in most instances, you would need to take on huge risk. And that will drop you right back down to being a Hare. Most people start with a smaller account, it is simply the truth of life. And the hard fact of life is that a small account is not sufficient to sustain you as an income source.

But let’s look at that long-term view. We will start with a relatively modest account of £5,000. And we will use compounding over a five-year period.

The problem with trading initially when you have a small account, is that you ARE looking at the monetary returns. You make a few hundred pounds in a month and instead of realising how well you have done, you think, ‘I can’t live on that’. So, you beat yourself up and try and do more. If you only took a proper view on it, you would understand how well you are doing and how you are setting yourself up moving forward.

Let’s now say you decide to risk 2% per trade. Your target is 5% per month. And you are going to let compounding do its work. So, that means you will need to be ‘up’ by around 2.5 trades per month (if looking for 1:1 risk reward). You don’t need to take ten trades per day; you don’t need to double your account every week. Just 2.5 solid trades per month.

If you only focused on the monetary return, it would be easy to get disheartened. By the end of 12 months, you would only have £8,942 in your account. Again, you start to think that you can never live on those sorts of returns. This is where people go wrong. Again, the desire to up your risk comes in. Disaster ALWAYS follows. What you should be focused on is the fact that you are making great returns in percentage terms. And you are building your trading knowledge and your discipline. JUST KEEP DOING WHAT YOU ARE DOING.

By the end of year two you are at £16,060.

By the end of year three you are at £28,841

By the end of year four you are at £51,795.

Do you see the power of compounding in action? What if you decide to go for another one year?

By the end of year five you are at £93,000!

Now, do you think by the end of four or five years you have not only the ability, but thanks to compounding, also the account to look at trading as a more serious venture? And here’s something else that you can do – at the end of that time, take a look around at all the Hare’s who were chasing the fast cash and the huge returns. I can guarantee you they won’t be trading full time and will either be running through another cycle of ‘ok, this time I got this. I am going to make so much money!’ Or else they will have stopped trading altogether.

The problem with compounding is that people don’t let it have the time that is required for it to work. It is a snowball, that grows exponentially the more you roll it down the hill. You start small and you just stay focused on the process, not the outcome.

Five years. You can either ignore it and keep running full speed ahead like the Hare, lots of pace but never getting anywhere. Or, you can accept the reality of the task at hand and start building your foundation for the rest of your trading career.

I hope you’re all having a great trading week!

How Long is a Piece Of String? How Long Will it Take to Become a Trader?

Reading Time - 6 Minutes

This blog post is in relation to an email I received today. The post itself isn’t aimed at that person, but it brought up a good question that doesn’t have a definite answer. I have touched on this before in blog posts, but it is one of the most common things I get asked and it also leads to a lot of people despairing and beating themselves up.

The question is – ‘How long will it take to become a trader?’ Or, it can come whilst the person is learning to trade, and is usually something like – ‘I have been trading for X months now. How is my progress looking? How much longer do you think until I am consistent?’

The answer, really, is to ask – How long is a piece of string?

But that isn’t fair when it comes to trading. So, the question should be – 'How long is a piece of string? That is on fire. And every time you bend down to measure it, you get burned. When you then pull away from the string and stand up, just as you start to blow on your burned fingers… a truck blindsides you and runs you the fu** over.'

What an enjoyable, leisurely stroll through life this trading lark is, right?

I don’t mean to put a negative spin on trading. I always lean towards the ‘harsh’ in the blog posts/videos, because I want people to understand that this is a difficult industry. There are enough people out there already promising riches and fast cash. They are, at best, idiots. And at worst, liars. You absolutely MUST come to trading with your eyes peeled wide open if you hope to stand a chance of success. If not, that truck will keep running you over and taking your credit card details at the same time.

So, let’s start looking at this string. Did I mention it was on fire?

The problem with asking ‘how long’, is that you need to make the leap of faith that you ARE going to make it and will be sitting at your desk 10 years down the line, a seasoned full-time trader with a coffee beside you and your ‘work clothes’ no more than your pyjamas. But that isn’t the case.

For a very large portion of people – estimates range between 80% and 90% - they will not make it. That is the failure rate of retail traders. Either they give up or lose their account and can no longer trade. It doesn’t matter if you go it alone. It doesn’t matter if you spend £300 on Zone Trader. It doesn’t matter if you spend £2,000 or £10,000 on a training course (and yes, there are plenty out there who will charge as much).

So, there can be no answer to ‘how long’, because there is no way to determine if you will get there at all. However, there are things we can look at.

You need to stop thinking about a training course as the holy grail. The human mind has a tendency to revert back to laziness. It does this because lazy uses less energy. Lazy is preferable, because it has less resistance and is easy. If purchasing a course, the tendency is to switch from ‘I really want to become a trader’ to, ‘Ok, now it is just a matter of time’.

That is a big mistake. You need to keep your guard up. And I mean that sincerely. Whether you are one year into it or five. Keep that shield polished and braced right in front of you. Trading, even successful trading, is a game of inches. You will fight tooth and nail to pull yourself forward. But one slip and you can go tumbling backward down a very jagged and unforgiving mountain.

A course is like an apprentice being given a toolbox full of the highest quality tools. Great. But he still needs to learn to not only use them, but use them professionally. Otherwise he is still going to produce terrible work.

Look at the course as a steadying hand. It cuts through a lot of the bullsh** and helps you compound the stuff for you to focus on. It’s a roadmap, but you still need to drive it.

On that note – stop looking for the ‘magic bean’. Nothing and no one is going to show you a secret indicator or setting that will suddenly turn you into a professional. That is a huge mistake so often made by traders. There isn’t a sudden ‘click’ as a beginner switches to a pro. Again, it is a long slog where you not only learn how to do it, but also retrain your mind. Do you honestly think if there was an indicator or bot that could do it for £100 or £2,000 the banks would be spending hundreds of millions per year on trading algorithms and automated systems that are CONSTANTLY monitored and updated?

So, how long? It is the question on your mind. It is how we work. We DO look to measure the string.

It depends on the individual. But a ‘safe’ bet is to say it will take you at least one year of learning before you can be considered anything nearing ‘competent’. And I am not talking about 1 year since you figured out what ‘bearish’ and ‘bullish’ means. I mean one solid year from when you start learning and putting the specific trading plan you are going to use into action on the charts.

You may even make profits in this time, but I can promise you that it is in no way a representation of how your long-term experience will pan out. Quitting your job at this point would be an enormous risk and, in my opinion, a huge mistake.

After that first year, that is when you ‘know’ your trading plan and how to implement it correctly. So… easy from there, right?

Nope. Remember that truck? Well, here it comes again.

Your trading plan should now be internalised, sure. But that mushy thing between your ears? That grey matter that propelled you to the top of the food chain? Well, that mass of goo has had thousands and millions of years of learning and evolving to make you who you are. Which is great, most of the time. But when it comes to trading, it is a huge hindrance. The mind wants to avoid risk and danger. It wants to keep you safe. It doesn’t understand that you need to risk and deal with uncertainty in the markets in order to gain. Basically, it is going to be your worst enemy for a good while.

Mistakes will continue to happen. You will know exactly what to do and then do the exact opposite. Afterward, you won’t have any good explanation for why you messed up so badly. This will result in extended periods of anger at yourself, bouts of depression, and an overriding desire to give up.

Now is usually about the time people start to fall away from trading. There is absolutely nothing wrong with that at all. It IS NOT for everyone. If it were, the success rate would be 100% instead of 10%. If you decide it is not for you, just walk away. It isn't failing, it is deciding to focus your energy on something else that suits you more.

After the second year, I think one to two years is how long it takes to really understand yourself and train your mind to operate when trading. It takes that long to first make all of the mistakes, then make them a few more times, and finally start to address where you can make small improvements and changes. 

Too long! I'll do it faster!

Sure, sure. I hear it all the time. And some DO get there faster. But, most do not. Remember - millions of years of evolution to create your brain and its operating system. A few years to wipe it down and install your new programme. In the grand scheme of things, it is still a very short timeframe.

But remember, this is not a definite overview. You may take 4 years to get to the point where you are ready to start making changes and learning how to cope with the uncertainty. It could take that long before you’re willing to accept that taking every pin bar doesn’t actually work and you need to start being more disciplined.

And then you come to realise that the rope you’re trying to measure… it has no fuc**ng end!

It keeps going and going. Does a football player get signed by a team and then suddenly there they are, finished the journey? They continue to train every day. They work on improving every day. They also make occasional mistakes, but as a professional they are far fewer than when they were first starting out.

That will be you as a trader. The consistency may appear, but you are always in danger of losing your way. If you allow that lazy brain to take over, you will slip and you will fall. It is a constant battle to maintain what you have built.

But… if you have a passion for trading… it is also one of the best journeys you can take.

As always, I hope that was helpful!

James Orr