Strict Rules On Investment Betting.
The Financial Conduct Authority (FCA) has published a consultation report proposing tougher rules on firms selling “Contracts for Difference”, sometimes known as “spread betting”.
What is a Contract for Difference?
It is an agreement between a buyer and seller to exchange the difference between the opening price and closing price of a currency, share, financial instrument, other investment, stock or contract.
The problem being that you are physically not buying or selling the actual stock, it is a type of “future” contract. You may have heard the term “short selling” where people actually selling a stock option before they even own it. E.g. Selling a stock option at the start of the day at a lower price than it is, driving the market down, and then buying the same, so that you sold and bought on the same day, you sold it before you owned it, but scraped through. It all looks so simple. You can use CFDs to speculate on the future movement of market prices regardless of whether the underlying markets are rising or falling.
Ultimately, with CFDs , you are betting and buying the difference in price. These are highly complex anyway, but when you introduce the concept of gearing, this is when it moves to another level of risk. Gearing, is where you only put a deposit down on the contract. Imaging you put a £1 deposit on a £20 contract. The contract then goes up to just £2. You then sell and you have made a profit of £2, you have doubled your money, that’s 100% return in a matter of a few days. Now, imagine that gearing is 100 times not 20 times the risk and return. This is the problem, people are losing money.
82% Are Losing Money
The FCA’s analysis of a sample of client accounts for CFD firms found that 82% had lost money on CFDs.
In addition they found that some firms were allowing inexperienced ‘retail’ investor clients with gearing up to 200 times. Imagine, the above £1 deposit CFD on £200 stock and that stock when down 5%. That’s down now to £190. On your £1, you have lost £10. That’s a 1000% loss!!!
The FCA is proposing to protect consumers by limiting the risks of CFD products and ensuring that customers are better informed. The new measures include:
Standardised risk warnings
Mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of these products.
Lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1.
Capping maximum leverage/gearing for retail clients at 50:1, only professional investors and managers can take on a higher gearing position
It is about time the FCA took a position on this. CFD’s and other geared financial instruments are extremely high risk. With 82% of retail investors losing money, they have left it too late. But the move to publish average profit and loss ratios for a firm’s clients is a great one to fully illustrate the risks involved.