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New NFA Rule Impacts More Than Just Forex Hedging

A couple of weeks ago I posted on the new NFA rule which effectively bans the practice of “hedging” in the retail forex market. There’s been considerable discussion on the subject of hedging and several notable brokers have given their customers the opportunity to allow them to shift their accounts to jurisdictions outside the US to permit those who wish the ability to continue hedging.

One of the parts of this new rule (2-43) that I didn’t initially focus much on is the FIFO (first-in, first-out) requirement. Some discussion about it, however, It’s made pretty clear:

Forex Dealer Members may not carry offsetting positions in a customer account but must offset them on a first-in, first-out basis. At the customer’s request, an FDM may offset same-size transactions even if there are older transactions of a different size but must offset the transaction against the oldest transaction of that size.

This FIFO requirement means that you can no longer chose which position you close if you have more than one trade open. If you are long and sell the broker will offset the earliest part of the long first. For example, if you bought a lot of EUR/USD at 1.3000, then later bought another lot at 1.3050, then sold a lot at 1.3100, the initial 1.3000 lot would be the one offset.

I do not “hedge” so the no carrying of offsetting position doesn’t phase me or most forex traders. The FIFO thing, though, is something which will impact a lot of folks. Basically it will mean that you won’t be able to close specific trades (stop or take profit) out of the sequence in which they were entered. Most forex brokers currently allow you to put a stop and/or take profit right on a specific position. This will not be permissible anymore under the new rule because they will be required to close your first trade before closing any others.

Now, if all you do is trade a single trade at a time, this my not be that big a deal. It depends on how you work. What it seems likely to require, however, is having to put on separate stop and take profit orders. This may seem fine, but consider a situation where you’re away from your computer and your stop gets hit, then later the take profit order is hit. You’d end up with a position you’d never intended. This is solved by setting up a One-Cancels-Other (OCO) order, but not all brokers do that at this point. Hopefully they will be pressured into changing that now.

I’ve spoken with someone at FXCM on this issue. It’s one they (and I’m sure all others) are working hard to figure out.

I’ve said from the start that this new NFA rule is just about getting retail forex in line with other markets like stocks and futures – standardizing the accounting for trades and positions. This FIFO thing is just doing that. I’ll admit it creates a bit of a shift in the mechanics of putting orders in and such, but if you’ve ever traded stocks, futures, or any other markets then it won’t be unfamiliar.

By John

Author of The Essentials of Trading

14 replies on “New NFA Rule Impacts More Than Just Forex Hedging”

This is particularly bad for people who scale-in and scale out of positions. (Mathematically I think its the same, but confusing nonetheless). I knew something like this would happen the minute I heard “government” arrrrghh

MN – Yeah, the math all works out the same, but this will force some changes for folks in the way they actually set up and execute their orders.

This is all a mess… no way around it. And most traders still do not understand what hedge / offset order is. I trade just Eur/Usd and I trade opportunities. So, a lot of my trades will be inadvertent offset orders. Not some blatant willy nilly immediate hedges like some people think hedge is. I see an opportunity to go long and short, set my TP, SL and then I forget about it. Until I see another trading opportunity. And most of my trades end up being winners. This really is a bizarre limiting ruling to grossly limit and handcuff successful traders. Let traders the way they want to. This BS is designed to do what in their puny mind anyway? Protect the traders? The market? What? Their capitalization requirement was a joke and this ruling is just downright pathetic. Now I fully realize that NFA is a damn moron.

Jonny – Sounds like your “go long and short” strategy is a straddle type of play. Do I read that right?

I think if the NFA came through and said we”re making these rules changes to get retail forex accounting in line with the rest of the markets (which is all it really does) and avoided the “to protect traders” bits the changes would be a bit more palatable to folks. There would still be squawking to be sure. They were never going to avoid that.

As for the capital thing, I don’t feel like requiring some fixed minimum absolute capital level is really the way they needed to go. Essentially, that restrains competition. A capital level relative to customer assets strikes me as being all that’s required. All you’re trying to do there is to make sure customer accounts are protected.

John makes a great poitn and is one I have wished for for a long time.

OCO and If-then ordering would just be absolutely the best thing since sliced bread. I have been looking for a package that will let me work this way.

Anyone have any suggestions?

Richmond FX, when they were around, had a great entry order system, if I remember correctly.

I only demo’d their system though and didn’t get that involved in it. They ahd all sorts of OCO orders pre set without having to write any code. You simply filled in the blanks.

I would suggest to FXCM to have a look at their old system.

As I read the rule, I do not see the FIFO part of the rule applying to anything except the offsetting or hedged positions. Here is the sentence that applies:

“Forex Dealer Members may not carry offsetting positions in a customer account but must offset them on a first-in, first-out basis.”

The operative words are “must offset them…”. The word them refers to offsetting positions.

If you are only trading in one direction, ie, only long or only short, then you can still close your open orders in any order that you wish. People are getting all bent out of shape about the FIFO rule, when it only applies to the closing of what would otherwise be offsetting positions. Not that I like thenew rules. I would rather the government let us trade like we want to. I am a big boy and do not need a nanny looking out for me. But, lets not get all worked up and make it out to be worse than it is.

thepipeline – You seem to be thinking “offset” and “close” are not the same thing. I would contend – and from what I’ve heard the brokers see it the same – that the NFA looks at the two things being equivalent. That means if you have a long position on comprised of multiple different entries, if you do a sale/short of a fractional part of the existing position your broker will apply that sale/short to the earliest entered long.

You have to keep in mind that forex is more akin to futures than stocks. In stocks selling and shorting are not necessarily the same. In futures when you are long you have to offset that long with a short to close the trade. Thus, offset=close. Forex works basically the same way.

John- thank you as always for your valuable insight and opinions, you have been a great teacher through your many articles and books. My concern with this ruling though is that it may well have the effect of placing our US brokers at a competitive disadvantage- for example, I have been using a few expert advisors with good results, and have been checking to see if any multiple open positions have been offset inadvertently- so far, so good, but if it does happen, I guess I will find out how the trade will be affected after May 15th. If it means that the results will be degraded, I imagine that I will need to transfer to a broker elsewhere….

For those of us that aactually make money off long and short positions this sucks.

You should be able to ask the the broker for the option to hedge.

Has any found code to to dtermin the long or short buy. My EA worked great with both on the same pair.

The only work around is having two accounts and using the same profile, then changing the EA’s to go long or short.

psst

This new rule applies to retail customers. How does it apply, if it applies, to the market maker themsleves? As i understand it they requently offeset our postiions in the market with a Hedge. Does this rule affect the market makers in anyway and how would that affect retail currency exchange?

Dkoop – Market makers have always done offset accounting and viewed things in net terms. That’s how they’ve guaged their exposure and managed it. The ruling will not impact them in the slightest. Keep in mind the NFA is just forcing a singular required bookkeeping method (offset). Basically, they are just requiring that the brokers show customer accounts in exactly the same way they do their own.

Since this ruling has become active, I have had to close an NFA broker’s account due to trades no longer being processed by the automated platform and system I had been using successfully up to this point…another broker transferred an account to a different subsidiary overseas. At this point I will no longer worry about a trade being rejected for this reason, it does seem like a waste though, to have to deal elsewhere….

Very simple change from a US broker. I live in Australia and all brokers here allow hedging still and could not care less, we are not governed by the stupid US rules thank god.

Plus you can use any EA you like, my broker here makes there money via the spreads only, so they dont care if you win all the time 🙂

Problem solved!

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