EMH and ESMA; the Keys to Salvation in Financial Markets

In this post, we’ll take a look at:

There are rules, and there must be rules, laws, regulations, to achieve balance not only in financial markets, but also in every business, in our lives either.

Markets should be fair. But what is the meaning of “being fair”?

No one likes loss; and no one likes to stay in a losing position. The same is true when it comes to financial markets. If the balance in a financial market is disturbed, then no one will continue to trade in that market anymore.

 

What is EMH?

From Wikipedia, the free encyclopedia: “The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to “beat the market” consistently on a risk-adjusted basis since market prices should only react to new information.”

The interpretation of economic theories is not intended here, but sometimes very instructive points can be learned from them.

 

EMH; Simplified

One of the most important points that can be learned is that it is impossible to beat the market consistently. This statement seems obvious. But financial markets can only exist if this statement is never violated. In other words, traders do NOT trust the unfair markets.

It is clear that a trade in the financial markets may be closed either with a profit or with a loss. You can never expect to win all trades. But what happens if a person or a group can always profit from the market?

 

Compound Interest Rate Formula

Compound interest is calculated by multiplying the initial loan amount, or principal, by the one plus the annual interest rate raised to the number of compound periods minus one.

According to the formula, If a person can earn 10% profit with an initial capital of 50,000 dollars, monthly and consistently, without loss, and continue this profit earning for 5 years or 60 months, then after 5 years, he or she will have more than half of the wealth in all continents. Doing the calculation, PV will be the Present Value or 50,000 dollars, ri will be the monthly profit of 10%, and n is the period or 60 months. So:

f1

Now it seems impossible to always profit from the market. But in some cases, there have been groups of traders that have been able to find a way to gain very large profits from the market.

Read more about the tragic events and crashes of the market in the recent past.

The regulatory agencies stepped in after the tragedies like May 6, 2010 flash crash, and updated the rules, and are always trying to keep the markets fair. Otherwise, it can be said that the financial markets may even collapse.

Let’s get acquainted with one of these models of regulatory laws on financial markets.

 

What is ESMA?

According to Forexchurch.com, “ESMA (European Securities and Markets Authority) has just recently introduced new leverage restrictions for retail clients trading CFD’s with brokerages that are regulated within the European Union – including the United Kingdom (FCA regulation)”.

ESMA is one of the important and interesting laws that does not allow any trader to threaten the markets, even if possible.

In ESMA, leverage conditions are explicitly mentioned, and traders within the European Union are required to comply. In order to be able to work with a higher level of leverage, traders must provide evidence of being a professional trader in the financial markets.

 

esma-regulation

Fig. 1. ESMA Leverage Limits

 

An Interpretation of ESMA; Which Market is More Volatile?

There are many opinions about volatility in different markets. Some believe that the Forex market is violent and volatile. Others may believe the stock market is as such. Everyone comments on fluctuations and different behaviors in a market based on what they hear and also their experiences. But which market is safe and which market is truly volatile?

To answer this question, Figure 1 may help us. As mentioned, the rules and regulations have been established to control the markets and observe moderation so that financial markets are not harmed by traders. The ESMA regulation was also formed on this basis to protect traders.

Undoubtedly, various experts have spent thousands of hours and have studied and analyzed the financial markets well enough to establish the ESMA regulation. Therefore, it can be concluded that the conditions, risks, and volatility of different markets are also included in the experts’ studies. Hence, Figure 1 can be used, namely leverage limits in financial markets, as a reliable source for measuring the volatility of different markets in general.

As a rule, the higher the volatility and risks in a market, the less leverage traders can use.

According to Figure 1, major currency pairs has been given the right to use the highest leverage which is 30:1. It can be said that the Forex market is a most safe market in terms of volatility and risks. Whereas, the crypto market has the lowest leverage allowed (2:1), and this indicates the risk and extreme volatility in this market. Other markets are also between these two cases.

Therefore and as a last resort, it may be possible to answer once and for all the question of which market has the most, and which market has the least volatility.

In financial markets, laws always protect us.

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