Last updated: February 22nd, 2024
Australian investors need to know about leverage ratio limits when trading Contracts For Difference (CFDs), as well as the implications of not abiding by ASIC restrictions.
New changes came into effect to protect traders on 29 March 2021, but what exactly do the ASIC leverage restrictions mean for the average retail investor?
Most non-professional investors are haemorrhaging their hard-earned money when leveraging CFDs.
Important!
During one volatile period, ASIC reported that “CFD issuers lost more than $774 million in one five-week period – and more than 15,000 retail client accounts fell into negative balance owing a total of $10.9 million.”
Over 81% of retail investors lose money trading CFDs. That’s a stat that almost every leading CFD broker is obliged to display on their online platform – to protect you.
Don’t make any rash moves until you’ve read through this guide.
What Leverage Restrictions Did ASIC Implement?
You’ve probably heard of the Australian Securities and Investments Commission (ASIC) restrictions, and while some feel they inhibit investors’ ability to maximise gains, the reality in most cases is that there’s been a substantial reduction in losses since their introduction.
Upon introduction, there have been:
- 91% reduction in aggregate net losses (from $372 million to $33 million per quarter on average)
- 87% fall in margin close-outs (when loss-making positions have only enough equity to cover 50% of losses)
- 88% reduction in negative account balances for retail clients trading CFDs
There’s no denying the new legislation works.
So, what exactly are the specific restrictions that apply to retail client accounts?
| Instrument | Leverage Limit |
|---|---|
| Major currency pairs CFDs | 30:1 |
| Minor currency pairs CFDs | 20:1 |
| Gold CFDs | 20:1 |
| Commodity CFDs other than gold | 10:1 |
| Major stock market index CFDs | 10:1 |
| Minor stock market index CFDs and other asset CFDs | 5:1 |
| Crypto asset CFDs | 2:1 |
As you’ll have astutely established by now, the restrictions relate specifically to CFDs, not the underlying assets themselves, such as foreign exchange rates or shares.
Important!
Important! A CFD is an agreement between a trader and broker to exchange the difference in the value of a financial asset. In other words, a CFD is a leveraged derivative contract that allows investors to speculate on the price of an underlying asset without actually owning it.
Before the restrictions came into force, the maximum leverage investors could access was up to 500:1 for CFDs and derivatives.
(Related: How To Invest In Stocks In Australia).
What Was The Impact Of ASIC’s New Leverage Restrictions?
You’ve seen the extent to which the restrictions are slashing retail clients’ CFD losses, but the introduction of restrictions has also reduced:
- Overall CFD trading volume by 23%.
- Ongoing market volatility.
The introduction brought Australia in line with progressive “overseas markets, including the United Kingdom and European Union,” according to ASIC Commissioner Cathie Armour.
Important!
In the US, however, CFD trading is completely prohibited due to the inherent risks that investors face when leveraging.
If a country that is home to 400 million firearms deems CFDs to be dangerous, should you be worried?
Could A Complete Ban Be On The Cards?
Although the Federal Court of Australia has previously labelled CFDs as “financial heroin hits”, there hasn’t been any mention of a ban on binary options in Australia since 2019.
Given the success of the changes, there is speculation as to whether further restrictions will be imposed when the current restrictions expire in March 2027.
Pressure is mounting on regulators.
Important!
CHOICE, Australia’s leading consumer advocacy group, says, “Banning the sale of CFDs would bring Australia in line with international best practice.” But so far, the prohibition of CFD trading has yet to gain any meaningful traction, and things look set to remain as they are.
How Australian CFD Traders Can Adapt To ASIC’s Leverage Restrictions.
Chances are, if you’re an experienced trader in Australia, you may have already been forced to reduce your leveraged trades.
Whether you’re a new or experienced retail trader, where leverage is used, best practice involves:
- Setting tight stop-loss orders.
- Being more selective with asset classes.
- Staying well below the leverage ratio limits and avoiding the impulse to max out.
The absence of a risk management strategy is the common denominator for retail traders who incur massive losses.
(Related: How To Buy Tesla [TSLA] Stocks).
I won’t overwhelm you with the details right now, but you can mitigate a disaster by employing the following two entry-level strategies:
- Hedging involves offsetting positions to protect your portfolio against potential losses in a primary investment you’ve secured. For example, you can “short” the primary investment, betting that the price will actually go down to erase some or all of the losses during volatile periods.
- Diversification involves spreading your investments in other financial markets to mitigate the negative impact of a poor-performing asset on your overall portfolio.
(Related: What Are The Best Day Trading Platforms?)
Can Retail Clients Legally Circumvent ASIC’s Restrictions?
If you’re an Australian retail investor, you won’t find a CFD issuer that will offer you anything more generous than the upper limit of the leverage ratios.
Why Using VPNs Is Neither Big Nor Clever.
You can’t use international brokers outside of Australia to access higher leverage thresholds. If you’re thinking about using a virtual private network (VPN) to access higher thresholds in other countries, stop right there.
In case you aren’t up to speed on VPNs, they can be used to hide one’s location and identity. For instance, some people use a Brazilian VPN to access cheaper Spotify subscriptions or an Indian VPN to access cheaper Netflix subscriptions.
Could the same be done to access international brokerage platforms and higher leverage?
But doing so is both illegal and a violation of the brokers’ terms. It’s not something any sane advisor would endorse.
(Related: How To Buy Apple [APPL] Stocks).
The penalty for noncompliance could be five years imprisonment for individual investors and up to $555 million for corporations.
It’s simply not worth the risk.
Why Professional Trading Accounts Are A Bad Idea.
The threat of hefty fines hasn’t stopped some Australian brokerages like Pepperstone and CMC Markets from exploring and exploiting loopholes.
A retail client with a decent amount of trading experience can complete a short knowledge test to obtain a “professional” account, waiving leverage restrictions and regulatory protections.
Above: Most Australian CFD brokerages will give you access to higher leverage if you pass one of these two tests. The exact tests vary slightly from broker to broker.
“Professional” accounts can access trading instruments with leverage as high as 500:1.
The ASIC restrictions (or consumer protections) protect your financial interests – make sure you respect them.
What To Do If You Can’t Pay A Margin Call.
If you’re unfamiliar with the term margin call, that’s perhaps a good thing.
Important!
It’s a demand from your broker for you to add money to your trading account or close positions to bring your account back to the required level.
What Are The Consequences Of Failing To Pay A Margin Call?
Your broker (and lender) wants their money back. Some brokers will grant you a few days to pay a margin call, but others will take immediate action and:
- Liquidate your holdings to make up the difference, without asking your permission.
- File a negative report that impacts your credit score (and your ability to access finance).
And like any unpaid loan, it’s possible that the broker will take up legal action against you for any significant outstanding balances.
Final Word On ASIC’s CFD Leverage Restrictions.
In some ways, leveraging assets is similar to taking out a payday loan to finance a gambling addiction. If you score an early victory, you’ll keep pursuing that high, thinking that you’ve discovered some latent intuition.
However, the data shows that most retail clients lose money.
But the reality is that leveraged trades make use of borrowed money that doesn’t belong to you. We’ve all heard that sage piece of old investment advice: “Only invest what you are willing to lose.”
Are you willing to lose your money as well as a lender’s?
Tommy
Nelson says:
I attempted to use the “hack” to dodge conversion fees, but sadly after converting AUD to USD on a Wise account, there doesn’t seem to be a way to deposit that money into eToro; i.e. eToro recently disabled Wire transfers and Wise doesn’t support SWIFT transfers for sending USD to a bank in the US?
John Keys says:
CMC Invest are an abysmal in turning around new accounts.
Over 1 month to setup up an account with an investment trust, and still waiting. I was promised 5 business days.
Reg Watson says:
Given that China’s economy is going down the toilet how the heck do we expect an appreciation of the Aussie in 2024 ? We are tied to China.