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News & Updates

Credit card bans and the future of US retail forex

Last week I brought up the subject of a prospective new NFA ban on the use of credit cards to fund accounts in retail forex. There has been considerable discussion about this, as tends to be the case any time the regulators come out with new rules (or at least plans for them). Once more we are hearing the claim that the NFA (and CFTC) is out to kill retail forex in the US. A blog post at Forex Magnates on Friday definitely takes that view. I have a hard time agreeing with this.

Let me pick on one particular comment:

NFA has gone a long way trying to completely kick retail forex out of the US eventually reducing the number of retail forex brokers from several dozens to just 11. With FX Solutions heading out as well the number of US forex brokers may fall below 10 within few months.

There’s no doubt we have fewer US forex brokers now. Is that a function of NFA/CFTC regulations? In some cases, I’m sure it is – especially when we talk about minimum capitalization rules that were put into place. I would contend, however, that such consolidation is simply a natural product of a business that is maturing.

Think about what we’ve seen in retail forex in the last decade or so. Topping the list is the way bid/ask spreads have come down very sharply. This means less income for the brokers, most of whom operate in some fashion on a dealer-based model. To put it another way, profit margins have been squeezed considerably. Any time that sort of thing happens industry-wide you get consolidation as those companies unable to compete either go out of business or get absorbed by those who can.

I would suggest we’re likely headed for a handful of major US forex brokers. We need only look at the stock market to see how few big brokers there are in that sector despite the fact that it features a bigger customer base.

Now, this is not me disagreeing with many of the arguments against the NFA credit card ban. I actually think it’s somewhat silly in a lot of ways given the many ways customers can access and move around money. If avoiding the use of borrowed money is the main focus (and I’m largely in agreement on that) then this ban only makes it slightly harder, as others have noted.

One question I would bring up, though, is that of expenses. Who foots the bill for credit card transaction fees, which are generally in the 2%-3% range? My guess is in most, if not all, cases it is the customer paying that bill. Preventing the use of cards from that perspective automatically keeps traders out of a performance hole. This game is hard enough as is, as I observed in Starting to detail forex profitability data.

I’d still love to hear your thoughts on the credit card ban, by the way. Feel free to leave a comment below, on Facebook, or Twitter @RhodyTrader.

Categories
Trading News

Forex Trading – Volatility, Regulation, and Survivorship

There’s been considerable talk over the last few years about whether US regulators are killing (intentionally or otherwise) the retail forex business in the States. The latest round comes on the heels of word going around that the National Futures Association (NFA), the industry overseer of most US forex brokers, is looking to ban the use of credit cards (directly or indirectly via the likes of PayPal) for funding accounts [I’d love to hear your thoughts on that, by the way. Feel free to leave a comment on Facebook or Twitter @RhodyTrader]. Retail traders have been screaming about overly active regulators since at least 2009 when word came down that “hedge” accounting would no longer be permitted for US accounts and that FIFO accounting would be required (see No More “Hedging” for Forex Traders).

Here’s the thing, though. The figures actually don’t back up any “death of…” scenarios, at least from a regulatory perspective. The US brokers didn’t start reporting active trader accounts to the CFTC until Q3 2010 (with data retroactive to Q4 2009), so we don’t have good figures for the Q2 2009 period when the “no hedging” rules kicked-in, or for the quarter immediately thereafter. There is a dip in active accounts between Q4 2009 and Q1 2010, which may be attributable in some way to the subsequent 100:1 leverage restriction put in place at the end of November 2009 (see New NFA Retail Forex Leverage Restrictions), but that seems highly unlikely given that when the Commodity Futures Trading Commission (CFTC) lowered that leverage cap to 50:1 a year later (see New CFTC Rules for Retail Forex Trading) there was no noticeable impact on active accounts as we can see in this table:

Notice how the number of active US-broker accounts held quite level during the year from Q4 2010 when the lowered permissible leverage went into effect through Q3 2011 (figures derived from the quarterly reports compiled by Forex Magnates). The sharp drop in active accounts doesn’t come until Q4 2011, though there wasn’t any particular catalyst (Forex Magnates suggested the cumulative effect of increase regulation, but that seems unlikely given the sharp 1-quarter move) and the fall was across brokers.

What is really interesting to note in the table, though, is how stable the number of profitable accounts has been since about Q4 2010. It’s only twice dipped below 30k. This comes as we’ve seen persistent weakness in the number of active accounts, which could be attributable to reduced volatility in the forex market for the last year or so. We can see that in the Average True Range (ATR) reading in the weekly USD Index chart below.

Interestingly, the number of active accounts is now back down into the area it was in during late 2009 and early 2010 when volatility was also on the low end before it ramped up again as 2010 progressed, which is when we saw the jump in accounts. That may not be cause/effect, but if we see volatility rise and the active account numbers increase again we’ll know that it’s the markets (and increased competition, no doubt) which has put the US retail forex business under pressure, not regulation.

Getting back to the stable number of profitable accounts, though, we’ve got indications of survivorship in them. That means profitable traders are staying active (though as I noted a couple weeks ago, there is considerable turnover in the accounts making money each quarter) and unprofitable ones are dropping out, which is what you’d expect to see in any case. It’s just that these days we’re not seeing an influx of new accounts to replace the dropouts.