A leverage cap sets the position size a broker can open for a retail client. In the European Union, this cap is not the broker’s commercial choice: it appears in a legal text. Most presentations stop at the ratio shown, without saying what margin that ratio imposes in practice. This article takes the five tiers published by ESMA, then works through the margin calculation that follows from them.
What a leverage cap covers exactly
Leverage compares the capital committed to the position amount, called the notional. At 30 to 1, a margin of 1,000 euros carries a position of 30,000 euros. The required margin is the inverse of the cap: 100 divided by 30, or 3.33 percent of the notional.
Margin is not a loss limit. It only sets the capital tied up at opening. The margin close out rule then applies to the whole account, not to a single position. A leverage cap does not protect against an unfavourable move: it reduces its mechanical effect on the size of the position, nothing more.
The five tiers of the leverage cap published by ESMA
The European Securities and Markets Authority adopted these measures on 1 June 2018, and they have applied to contracts for difference since 1 August 2018. The tiers vary with the volatility of the underlying, never with the broker.
Major currency pairs stand at 30 to 1. Non-major pairs, gold and major stock indices fall to 20 to 1. Other commodities and non-major indices move to 10 to 1. Individual shares drop to 5 to 1, and cryptocurrencies to 2 to 1. ESMA, 1 June 2018
| Asset class | Leverage cap | Initial margin |
|---|---|---|
| Major currency pairs | 30 to 1 | 3.33% |
| Non-major pairs, gold, major indices | 20 to 1 | 5% |
| Other commodities, non-major indices | 10 to 1 | 10% |
| Individual shares, other reference values | 5 to 1 | 20% |
| Cryptocurrencies | 2 to 1 | 50% |
The left hand columns come from the ESMA text. The margin column is calculated: it equals 100 divided by the cap. ESMA, 1 June 2018
A leverage cap, two ways to read it
The ratio and the margin describe the same constraint in two forms. The ratio states the maximum size per unit of capital. The percentage states the capital tied up for a given notional. On a position of 20,000 euros in major currencies, the initial margin equals about 666 euros, or 3.33 percent of 20,000.
This calculation is an arithmetical illustration. It describes no rule of any trading programme, and it says nothing about the possible loss on the position.
What these caps do not say
A leverage cap does not prevent losses. It does not guarantee that a position stays open during an economic release. The ESMA tiers frame the retail clientele of the European Union only: another jurisdiction can set different tiers under its own text. A provider can always apply stricter conditions than the legal minimum, and several do.
These ESMA measures also do not deal with the rules specific to a trading challenge. The profit target, the maximum permitted loss and the daily drawdown fall under the programme’s own rulebook, not under the ESMA text. FCA, PS19/18, July 2019 Confusing the two amounts to comparing a market risk limit with an account management rule.
Sources
- ESMA, product intervention measures on CFDs and binary options, 1 June 2018, esma.europa.eu.
- Financial Conduct Authority, PS19/18, restricting CFD products sold to retail clients, July 2019, fca.org.uk.
A leverage cap is best read alongside the rulebook of the programme you follow. The mechanics of a prop firm challenge rest on written rules, a profit target and a loss limit that are separate from any leverage regulation. Comparing those rules with the caps above helps place the real risk of a position.
To practise on simulated capital, with rewards defined by the rulebook and without any promise of real funding, you can look at the WeGetFunded trading contest.