Do not invest more money than you can afford to lose.
The European Securities and Markets Authority (ESMA) – the EU authority overseeing the stability of the financial system of the Union, has published a document warning of the risks of trading in CFDs, binaries and other speculative financial instruments, such as rolling spot forex.
The ESMA notes that the increasing numbers of offers of speculative products such as rolling spot forex, binary options and contracts for difference (CFDs) to retail clients is bringing a surge in the numbers of complaints from investors who have suffered significant losses.
A recent report of the French regulator AMF, for example, showed that between 2011 and 2015 the number of complaints only in France rose exponentially – from 64 in 2011 to 1656 last year. They include complaints both against retail forex and binary options brokers. Separately, the AMF ombudsman Marielle Cohen-Branche released an annual report highlighting the fact that between 2014 and 2015 the complaints against binary options brokers, most of them regulated in Cyprus, has risen 62%.
“These products carry a very high level of risk,” the ESMA notes and quotes studies of national regulators who have found that retail clients speculating in CFDs, binary options and other speculative products in most cases lose the money they have invested. “For example, many of these products require investors to post money to a margin account and this money may be lost if the investment is out-of-the-money by an amount in excess of the money posted to the margin account,” explains the regulator.
The ESMA also notes the rise of unauthorized forex and binaries broker who go about offering their services unchecked – cold calling and luring gullible people to “invest” their life savings, promising easy profits. Hence, the regulator advises investors to check whether the company offering financial services is properly regulated.
The properly authorized and regulated brokers, however, are obviously not much different, according to ESMA: “Supervisors have also observed that they (the speculative financial products) are often marketed and sold in an aggressive way and that some firms fail to comply with their regulatory obligations under MiFID, creating the conditions for retail investors to suffer significant detriment, e.g. in the form of unexpected losses.”
Worse still, the brokers often fail to properly inform the potential investors that they may lose their money and emphasize on the eventual gains instead. “The retail investor might conclude that there is little or no risk involved when investing in speculative products. This is wrong,” the ESMA notes.
Another bad practice outlined in the document is the offering of “free start-up money”, gifts, discounted fees, or trading tutorials in order to attract retail investors as new clients.
Providers of CFDs, binary options and other speculative products may also offer “free start-up money”, gifts, discounted fees, or trading tutorials in order to attract retail investors as new clients, as well as the general lack of investment advice.
In conclusion the ESMA notes that many of the outlined risks for retail clients are caused by the business models of the companies operating in the sector and the inherent conflict between the commercial interests of the firm and the interests of the clients. One such conflict of interest may arise from a bonus system for staff who sign up most new clients over a period of time. Another arises when the profit of the firm is directly linked to the loss of the retail client.