Last week the major U.S. banks reported quarterly revenues that demonstrated their investment banking divisions have been picking up the slack from other parts of the banks that have taken a hit as a result of the Covid-19 pandemic. Market volatility has played into the hands of professional traders, who have managed to take advantage of the market swings over recent months.
Online trading platforms offering similar financial instruments to those used by investment bank traders, CFDs and spread betting, have also been among the financial winners over lockdown. But for the inverse reason. The retail investors that these platforms work with have been doing less well than their professional counterparts.
Most retail-facing CFDs and spread betting brokers act as market makers for smaller traders. That means they take the opposite side of the position traders take on which direction financial instruments will move in. So, when their traders close their positions to a profit, the broker loses money. But when the trader loses money, the broker profits.
Plus500, the FTSE 250 online trading platform, announced that its revenues almost tripled over the second quarter of 2020. Other London-listed companies in the sector such as CMC Markets and IG Group have also outperformed. The CMC Markets share price is at an all-time record high and those of IG Group and Plus500 up on where they began 2020.
However, investors considering the shares of online trading platforms in light of their recent strong performance should take into consideration the danger that the financial watchdog steps in to limit how CFDs and spread betting are marketed to inexperienced retail investors. An investigation by The Times newspaper highlights how market volatility might boost the profits of professional traders but that it has increased the losses being taken by inexperienced amateur traders. That is backed up by a warning from Plus500 that a whole 80.5% of the retail accounts it hosts lose money.
In January, before market volatility heightened due to the Covid-19 pandemic, 76.5% of Plus500 traders were losing money. The losing rate increased from 70.5% of accounts before the pandemic to 79% for CMC Markets account holders. For IG Group traders, the percentage of those losing money increased from 68% to 76%.
The Financial Conduct Authority, which regulates financial markets in the UK, and its counterpart in the EU, have both recently tightened rules around derivatives trading for retail investors.
Trading CFDs, or spread betting in the UK, typically involves the use of leverage. The use of leverage, which basically means borrowing against a deposit to increase the value of a trading position, multiplies profits for winning trades but also multiplies losses. The FCA reduced the amount of leverage brokers can offer retail traders, especially on more volatile instruments such as cryptocurrencies. But given the number of amateur traders still losing money, regulators could be tempted into taking further measures.
All three companies have reported an upsurge in new trading accounts being opened in recent months. More new, inexperienced traders is likely a major explanation to why the percentage of retail traders losing money has increased.
The brokers themselves have defended how they advertise and promote trading to their retail account holders. Plus500 issued a statement in response to The Times investigation which read “We always aim to protect our customers”.
CMC insisted that it does not target inexperienced would-be traders and rather that “the group targets high value, sophisticated traders”. For its part, IG stated “we take proactive steps to ensure our products are only available to those for whom they are appropriate.”
If that’s enough to convince the watchful FCA remains to be seen, with the regulator itself commenting:
“This is the reason we intervened in this market to limit the sale of these products that result in harm to retail consumers.”
This article is for information purposes only.
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