Retail derivatives vs Holding Underlying Cryptocurrency – will ESMA be a game-changer?
Currently, it is hard to avoid the almost daily news on “Cryptocurrency”, “Blockchain” or “Bitcoin.”
All of these terms are regularly banded around and in many circles these terms have become (incorrectly) a byword for one and the same thing.
For every evangelist of one or all of these terms there are an equal and opposite number of harbingers of doom. Whichever way you look at it- the whole “Blockchain” topic won’t be going away anytime soon, with Blockchain news and speculation sure to dominate our lives, and its underlying technology sure to become a key part of future technology.
An inevitable by product of this new sector has been the angle that speculators and investors have sought for a money making opportunity, with the current overall volatility creating large potential opportunity of gains for participants. The most viable way to do this is through the burgeoning market of spread betting or contracts for difference (CFDs) on Cryptocurrencies. As such, organisations that are able to support and offer these products have been channelling advertising spend to snap up clients looking to get involved in this new and exciting market.
But is it all that it is cracked up to be and is there a viable alternative?
Spread betting or CFDs
This is by far and away the most accessible way of getting involved in the space. For the few that don’t already have a spread betting or CFD account, simply fill out some online forms, provide your identification, deposit some funds and if you pass the Know Your Customer (KYC) and suitability, you are away. Typically, the coins you have access to are restricted to those with the most liquidity- namely the top 20 and the speed to get in and out of each trade is as simple as clicking a button. However, due to cryptocurrency volatility, margin requirements have always been high – and for European traders, that situation will only get worse when the EMSA leverage restrictions come into force on August 1st. The maximum leverage for retail clients will be 2:1, meaning an allocation of your deposit against an open position, and the reality that a move against your position will result in further deposits of margin to maintain the position and thus avoid automatic “closing out” and subsequent loss of funds. (Something that can’t be discounted with 5% moves in a day not uncommon.)
There is also the small subject of “funding” each trade, something spread betting and CFD providers impose on their clients. As the client is only required to deposit a proportion of the actual size of the trade in their account to open it (the margin requirement) this funding charge is made for holding the position overnight and typically varies from an annualised rate of around 30% and upwards depending on which company that you use. This daily charge against any open position is quite well hidden and can add up. (I.e. if you had a position open for £10,000 of Bitcoin, you would face a charge of upwards of £3000 per year in order to have that position open, which would then need to be offset against any gains/losses that you make.)
Delivering the Underlying Cryptocurrency
Whilst a comparatively less marketed channel, there are brokers entering the marketplace that offer clients the ability to own the actual underlying cryptocurrency purchased which immediately removes any form of funding or margin implication which can ultimately be prohibitive if using a spread betting or CFD provider. Users can also freely buy and sell the cryptocurrency that they own and move it back to Fiat currency (e.g. sterling, euros or dollars) as and when they choose to. The KYC and account opening process for these brokers tends to mirror that of opening a spread betting account although some may have additional proof of funds checks to further identify clients and the underlying transactions they wish to make. In addition, some brokers enable clients to buy and sell not only the top 20 cryptocurrencies but also a number of the more esoteric currencies, known as “Alt” coins, which provides a real opportunity for those wishing to invest large or small amounts in smaller “start-up” businesses (ICOs) in the sector.
When it comes to holding the underlying coin, this is where things are slightly more detailed than the spread betting environment. Firstly, the client will need to open a wallet that is relevant to the underlying cryptocurrency being purchased. This is a relatively straight forward task and most popular wallets are able to house all of the top tokens/ currencies (reputable brokers will assist with this set-up for you). However, there is not one wallet that houses all currencies/tokens and there are many tokens where another wallet will need to be set up. Transactions to and from these wallets of your coins tend to be extremely fast and whilst also safe, it is fair to say that there is no complete guarantee of safety of your coins from attack and ultimately theft. This can be counteracted by either moving your coins to a “cold wallet” held offline which provides a much higher degree of safety, but does mean some expenditure to get set up. Alternatively, a client could utilise safe custody which is offered by some reputable brokers for a relatively small annual charge. This removes the need for wallets altogether as coins will be stored on your behalf in cold storage and then be moved back onto exchange as and when the client is next looking to buy or sell.
For some, the convenience factor of spread betting will always offset any sort of margin or funding that is put up to enter these trades along with the speed of entry and exit. After all, normal spread betting and CFD trading of stocks, currencies and indices attracts funding charges and margin and this hasn’t put clients off thus far. If as expected, the crypto market evolves then you could feasibly expect to see volatility reduce. Such a move would normally see more generous leverage limits, but the regulatory change from ESMA has put pay to this – at least for now. In turn, this has the potential to drive more investors to buying and holding the underlying coin. The initial set up may be slightly more cumbersome however costs in terms of funding and margin disappear and the sheer range of coins that you have access to in any volume gives a lot more variety to the average investor. All of this means that there is a relatively easy access point for those that wish to diversify their portfolio or get involved (in any amount) in smaller tech businesses that they feel are going to thrive and be the next big thing. After all, the tech companies that dominate today were born out of the tech boom and imagine being invested in those in a very small amount from the very beginning!
About the author
David Thomas is a co-founder and director of GlobalBlock. He began his career at a Commercial Foreign Exchange company in 2003, which went on to become one of the UK’s largest non-bank forex providers, which was subsequently sold to private equity in 2015. David’s belief in the future of blockchain and its underlying technology was a key factor in establishing one of the UK’s first phone brokered, deliverable cryptocurrency providers.
How has the online trading landscape changed in 2020?
By Dáire Ferguson, CEO, AvaTrade
This year has been all about change following the outbreak of coronavirus and the subsequent global economic downturn which has impacted nearly every aspect of personal and business life. The online trading world has been no exception to this change as volatility in the financial markets has soared.
Although the global markets have been on a rollercoaster for some time with various geopolitical tensions, the market swings that we have witnessed since March have undoubtedly been unlike anything seen before. While these are indeed challenging times, for the online trading community, the increased volatility has proven tempting for those looking to profit handsomely.
However, with the opportunity to make greater profits also comes the possibility to make a loss, so how has 2020 changed the online trading landscape and how can retail investors stay safe?
Interest rates offered by banks and other traditional forms of consumer investments have been uninspiring for some time, but with the current economic frailty, the Bank of England cut interest rates to an all-time low. This has left many people in search of more exciting and rewarding ways to grow their savings which is indeed something online trading can provide.
When the pandemic hit earlier this year, it was widely reported that user numbers for online trading rocketed due to disappointing savings rates but also because the enforced lockdown gave more people the time to learn a new skill and educate themselves on online trading.
A volatile market certainly offers great scope for profit and new sources of revenue for those that are savvy enough to put their convictions to the test. However, where people stand the chance to profit greatly from market volatility, there is also the possibility to make a loss, particularly for those that are new to online trading or who are still developing their understanding of the market.
The sharp rise in online trading over lockdown paired with this year’s unpredictable global economy has led to some financial losses, but with a number of risk management tools now available this does not necessarily have to be the case.
Protect your assets
Although not yet widely available across the retail market, risk management tools are slowly becoming more prevalent and being offered by online traders as an extra layer of security for those seeking to trade in riskier climates.
There are a range of options available for traders, but amongst the common tools are “take profit” orders in conjunction with “stop loss” orders. A take profit order is a type of limit order that specifies the exact price for traders to close out an open position for a profit, and if the price of the security does not reach the limit price, the take profit order will not be fulfilled. A stop loss order can limit the trader’s loss on a security position by buying or selling a stock when it reaches a certain price.
Take profit and stop loss orders are good for mitigating risk, but for those that are new to the game or who would prefer extra support, there are even some risk management tools, such as AvaProtect, that provide total protection against loss for a defined period. This means that if the market moves in the wrong direction than originally anticipated, traders can recoup their losses, minus the cost of taking out the protection.
Not a day has gone by this year without the news prompting a change in the financial markets. Until a cure for the coronavirus is discovered, we are unlikely to return to ‘normal’ and the global markets will continue to remain highly volatile. In addition, later this year we will witness one of the most critical US presidential elections in history and the UK’s transition period for Brexit will come to an end. The outcome of these events may well trigger further volatility.
Of course, this may also encourage more people to dip their toes into online trading for a chance to profit. As more people take an interest and sign up to online trading platforms, providers will certainly look to increase or improve the risk management tools on offer to try and keep new users on board, and this could spell a new era for the online trading world.
By Paddy Osborn, Academic Dean, London Academy of Trading
Whether you’re negotiating a business deal, playing a sport or trading financial markets, it’s vital that you have a plan. Top golfers will have a strategy to get around the course in the fewest number of shots possible, and without this plan, their score will undoubtedly be worse. It’s the same with trading. You can’t just open a trading account and trade off hunches and hopes. You need to create a structured and robust plan of attack. This will not only improve your profitability, but will also significantly reduce your stress levels during the decision-making process.
In my opinion, there are four stages to any trading strategy.
S – Set-up
T – Trigger
E – Execution
M – Management
Good trading performance STEMs from a structured trading process, so you should have one or more specific rules for each stage of this process.
Before executing any trades, you need to decide on your criteria for making your trading decisions. Should you base your trades off fundamental analysis, or maybe political news or macroeconomic data? If so, then you need to understand these subjects and how markets react to specific news events.
Alternatively, of course, there’s technical analysis, whereby you base your decisions off charts and previous price action, but again, you need a set of specific rules to enable you to trade with a consistent strategy. Many traders combine both fundamental and technical analysis to initiate their positions, which, I believe, has merit.
What needs to happen for you to say “Ah, this looks interesting! Here’s a potential trade.”? It may be a news event, a major macro data announcement (such as interest rates, employment data or inflation), or a chart level breakout. The key ingredient throughout is to fix specific and measurable rules (not rough guidelines that can be over-ridden on a whim with an emotional decision). For me, I may take a view on the potential direction of an asset (i.e. whether to be long or short) through fundamental analysis, but the actual execution of the trade is always technical, based off a very specific set of rules.
To take a simple example, let’s assume an asset has been trending higher, but has stopped at a certain price, let’s say 150. The chart is telling us that, although buyers are in long-term control, sellers are dominant at 150, willing to sell each time the price touches this level. However, the uptrend may still be in place, since each time the price pulls back from the 150 level, the selling is weaker and the price makes a higher short-term low. This clearly suggests that upward pressure remains, and there’s potential to profit from the uptrend if the price breaks higher.
Once you’ve found a potential new trade set-up, the next step is to decide when to pull the trigger on the trade. However, there are two steps to this process… finger on trigger, then pull the trigger to execute.
Continuing the example above, the trigger would be to buy if the price breaks above the resistance level at 150. This would indicate that the sellers at 150 have been exhausted, and the buyers have re-established control of the uptrend. Also, it is often the case that after pause in a trend such as this, the pent-up buying returns and the price surges higher. So the trigger for this trade is a breakout above 150.
We have a finger on the trigger, but now we need to decide when to squeeze it. What if the price touches 150.10 for 10 seconds only? Has our resistance level broken sufficiently to execute the trade? I’d say not, so you need to set rules to define exactly how far the price needs to break above 150 – or for how long it needs to stay above 150 – for you to execute the trade. You’re basically looking for sufficient evidence that the uptrend is continuing. Of course, the higher the price goes (or the longer it stays above 150), the more confident you can be that the breakout is valid, but the higher price you will need to pay. There’s no perfect solution to this decision, and it depends on many things, such as the amount of other supporting evidence that you have, your levels of aggression, and so on. The critical point here is to fix a set of specific rules and stick to those rules every time.
Good trade management can save a bad trade, while poor trade management can turn an excellent trade entry into a loser. I could talk for days about in-trade management, since there are many different methods you can use, but the essential ingredient for every trade is a stop loss. This is an order to exit your position for a loss if the market doesn’t perform as expected. By setting a stop loss, you can fix your maximum risk on a trade, which is essential to preserving your capital and managing your overall risk limits. Some traders set their stop loss and target levels and let the trade run to its conclusion, while others manage their trades more actively, trailing stop losses, taking interim profits, or even adding to winning positions. No matter how you decide to manage each trade, it must be the same every time, following a structured and robust process.
The final step in the process is to review every trade to see if you can learn anything, particularly from your losing trades. Are you sticking to your trading rules? Could you have done better? Should you have done the trade in the first place? Only by doing these reviews will you discover any patterns of errors in your trading, and hence be able to put them right. In this way, it’s possible to monitor the success of your strategy. If your trades are random and emotional, with lots of manual intervention, then there’s no fixed process for you to review. You also need to be honest with yourself, and face up to your bad decisions in order to learn from them.
In this way, using a structured and robust trading strategy, you’ll be able to develop your trading skills – and your profits – without the stress of a more random approach.
Economic recovery likely to prove a ‘stuttering’ affair
By Rupert Thompson, Chief Investment Officer at Kingswood
Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.
As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.
Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.
We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.
Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.
Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.
China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.
Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund. As is almost always the case, a messy compromise will probably end up being hammered out.
An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.
Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.
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