Trading News

New CFTC Rules for Retail Forex Trading

Can I say I told you so? 🙂

The CFTC has finally come through with its new rules on retail foreign exchange, which come into effect on October 18th, 2010 (Q&A about the new rules can be found here). Despite fears to the contrary, the CFTC will not be cutting permissible leverage in retail forex trading down to 10:1. The people have been heard! There was so much contrary opinion against that move from traders and brokers that the regulators were forced to rethink the plan.

That said, the CFTC will, however, be restricting leverage to no more than 50:1 (2% margin requirement) on the major currencies (5% on regional currencies). This is basically taking the NFA restriction put in place last year for 100:1 max leverage and tightening it up. I’m sure that’s going to have some folks up in arms, but the reality is that most of your better traders never go much beyond 10:1 actual leverage. Further, one of the biggest forex brokers out there, Oanda, has never permitted more than 50:1 leverage.

I know this won’t have any impact on my trading, nor encourage me to move my account outside the US. What about you?

By John

Author of The Essentials of Trading

21 replies on “New CFTC Rules for Retail Forex Trading”

Based on proposed mandates for higher margin requirements in other commodities (namely energy, which is the realm I work in), do you think the CFTC is overstepping their bounds as a governing body. Let’s not forget, most of the people at the CFTC have never worked in futures or options trading, and the NFA is protecting our rights as a collective trade association.

Clearly, my opinion is bias as my boss is on the board of the NFA and I work in the industry, but I am curious to your POV.

John, I don’t either. But hey, that’s just my (our) way of doing things. There are many many ways of approaching the markets, and if someone has worked out a way to be consistently profitable taking adavantage of the 100:1 leverage, I hate to see that being restricted by a third party to the transaction, who has no interest and no way to benefit from said transaction. Basically it implies that all people are stupid and need to be protected from themselves, and I am just tired of that kind of interference in a valid agreement between private parties.

I won’t disagree with the “nanny state” aspect to things. I would note, however, that going to max 50:1 leverage for retail forex brings it closer in line with the futures market, which of course the CFTC also regulates. I think futures margins are in the 2%-5% range, depending on the volatilty of the market. That said, it’s the exchanges which set the margin requirements because there’s a clearinghouse functionality involved. We don’t have that (yet anyway) in forex.

I see your point, however, what worries me is that I don’t see an end to this trend of constant interference. Moreover, often you will see no significant benefits from the regulation, but you definitely have the potential unintended consequences. The first comment above by TCG makes exactly the same point: Proposed mandates for higher margin requirements in Energy contracts. What evidence do they have that low margin requirements (therefore high leverage) fueled speculation in Crude Oil in 2007-2008. By lowering margin requirements you facilitate trade and liquidity; you enable price discovery. If you want more volatility in Energy prices, then by all means take liquidity away from the market.

Indeed a very sad day.

John, sorry but I don’t think that going to max 50:1 leverage for retail forex brings it closer in line with the futures market. Not sure about 6E, but my futures broker has an intraday margin requirement of $500 on ES. With one contract worth more than $50k, the futures market is operating with more than 100:1 leverage.

Bottom line, the rule puts spot forex retail trading at a disadvantage compared to the futures market. Well, this market won’t sink right now, like you said, but I would expect to see a constant shifting of traders (as they realize this) from spot forex to the futures market. It’s the long run perspective that seems worrying.

The lower intraday margins brokers allow for futures is a function of the clearance process. The brokers only have to post margin on your behalf for the positions you hold at day’s end. As such, they are free to go with something lower for intraday trades. Obviously forex doesn’t have the clearing house element, so the structure is different. If you look at the whole collective of forex regulatory changes put through by the CFTC and NFA, though, you can see the clear shift toward a common standard.

As for putting spot at a disadvantage, I hold firm to my disagreement. Topping my list of reasons why that isn’t the case is the contract size side of things. Futures micro contracts are more like what mini contracts are in retail forex, and you definitely don’t have the equivalent of brokers like Oanda who have no fixed contract sizes.

Hey John,

I’m actually kind of at a disadvantage with 2% margin requirements because that means that I have to have around $18,000 in my account just to be able to buy my 6 standard lots of GBPJPY which I need to be able to do as part of my trading plan. With 1% margin, I only need $9,000. If my trading plan calls for an initial capital of $25,000 plus the cost of entry, I can earn a much bigger percentage return on $34,000, than on $43,000 trading the exact same way.
With the new requirements, the initial capital needs to be more and it becomes harder to show superstar returns.

Jon, I need a bit of clarification. When you say “initial capital of $25k plus cost of entry” am I right that the $25k is basically a buffer against drawdowns? If so, that implies you’re willing to ride through a near 75% drawdown (closer to 60% if you’re talking a 2% margin). Am I reading that correctly?

Hey John,

Yes that’s correct. I’m willing to ride that level of possible drawdown based on testing and backtesting (using pretty good historical data of around 10 years as far as backtesting) since that would take precaution against the unlikely event that I hit max drawdown right away (and the max drawdown level has only come close around a handful of times in those 10 years). My average drawdown is around $5,000. Using this system I can get extremely high returns basing my initial capital on the drawdown buffer plus max cost of entry (I don’t always take a 6 standard lot position, mostly around 2 lots, so the excess capital not used in entry can also be used to add to that drawdown buffer).
Do you think I need a lot more initial capital anyways, even with 1% margin requirements?

Thank you!

It is true that for the majority of traders with a sizable sum of money to trade, a 50:1 leverage is fine. However, for those with just a few hundred to start with that want to parlay that amount into thousands and then hundreds of thousands, the larger leverage is absolutely necessary. It is these very people that the government is trying to “protect” by keeping poor and broke, taking away opportunity to get ahead. History is full of small time people who made it by risking everything they had, many times losing it multiple times.

With a 50:1 leverage, it would be very difficult to have the margin required for the small person.

Peter – With a 50:1 leverage, it would be very difficult to have the margin required for the small person.

This is totally incorrect. Brokers like Oanda have no fixed trade sizes, so you can trade as little as 1 USD, EUR, GBP, etc. And even micro lots at 50:1 don’t require large accounts. Margin for a micro lot ($1000) of USD/JPY is only $20.

I will still make my money, but I have newbies I’m training that don’t have their emotions under check yet. The increase in margin will give them a much larger cushion before a margin call. I can’t imagine a 340 pip stop on the GBP/USD but I know traders will think they can hold out longer and expect to recover such a large move against them.

I have to say that 100-1 lev. is crazy. 50-1? while I will still keep my 2 small U.S. based accounts open and occasionally place incubators in there, I will continue to make 90% + of my money doing binary options, vanilla options and using my 2 overseas based accts. But it saddens me to see the demise of the US forex business. And btw, since I am not a “whale”, how in the heck could I or would I tie up my money at 50 – 1??

John, what I mean is that I know a person that is in the industry and have been told that they are losing up to 50% of their clients, and while the churn rate is racing up, the new signees is a trickle. it only makes sense. Why would i trade on my US based brokers at 50-1 when my UK based accounts are giving me 400+-1?? if they really wanted to clean up the industry, they would go after the stop hunters and those brokers whose only reason for existense is to trade against you.

Paul – First, the CFTC/NFA rules changes definitely do go after the hucksters – starting with the “hedging” rule last year. You could tell a lot about the brokers by their reaction to that one – like encouraging accounts to shift off-shore only to now have to bring them back. I’m not buying the whole “death of the industry” bit. One of the biggest brokers out there (Oanda) has never offered more than 50:1 leverage and it doesn’t seem to have caused them any problems over the years.

I will most def look to open a forex account outside of US. Screw the CFTC! Who do these bitches think they are? If I want to trade with 100:1 margin then that’s what i want to trade. Are they worried about traders or are they worried that some people making money? This new rule is such a scam. Seems to me they want to keep little guys out. Until now I’ve kept my account balance at $10,000 for trading which allowed me to trade 1 Million lot but I only traded 500,000 to 600,000. Now in order to keep my profit system running I have to deposit $20,000. WTF???!!! I’m going offshore.

The biggest thing I see this rule effecting is stop loss hunting, it make perfect sense when you have a retail trader with lets say 2 or 3 million in capital who can flush out stop losses, get his trade off then walk away, it disrupts the real market for that particular pair. The massive spike in currency trading in the past week has gone bye bye, the rule has been effective. Kudos to the CFTC!

Mike – Retail traders are not price makers. They are price takers. I’ve seen estimates that put retail forex volume at something like $150bln/day while overall spot market volume is called $1.5trln/day. The forex rates are driven by the interbank market, not the retail side of things. Aside from broker manipulation of prices (which is not nearly the problem some would lead you to believe and is likely to be further reduced by the CFTC and NFA rules put in place the last year and half), what stop hunting there is done happens at the inter-bank level. And to what you said about volume (which I don’t quite follow), the CFTC rule hasn’t taken effect yet. That happens Monday.

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