By Steve Misic, Online Trading Academy XLT-Forex Trading Instructor
This week's article will review some of the new regulations affecting retail Forex traders with accounts in the US that are scheduled to take effect in August, 2009. The approval of Compliance Rule 2-43(b) became effective in November, 2008, but parts of the ruling are still being implemented over time to allow for changes to Forex trading platform software. This piece of the new regulation is designed to protect the US retail Forex trader from practices that the NFA (National Futures Association) has determined have no economic benefit to the trader such as the ability to hedge a position by going long and short the same currency pair in the same account. According to the NFA, this type of hedging increases the customer's financial costs by doubling the expense of entering and exiting positions. In addition, if the customer holds positions overnight, the differences in the interest rate rollover calculations will cost customers additional money over time if they are short high yield currencies. Several of the NFA Forex Dealer Members (FDMs) have admitted that customers receive no financial benefit by carrying opposite positions, but the FDMs believe that if they do not offer the strategy they will lose business to domestic and foreign firms that do. Several US Forex brokers have reacted to this ruling by encouraging their customers to open accounts with their overseas affiliates in order to continue to execute this hedging strategy. Other Forex brokers have made it harder for their customers to place protective stop loss orders and profit orders to protect positions. Many argue that their software still does not allow for First in, First out (FIFO) order executions. Below is an explanation of what FIFO is, and how one broker suggested their customers place protective orders in response to the ruling:
How to use Stops & Limits after July 31
Dear Client:
Please note that you will be able to use entry orders to place stops and limits after July 31, 2009. Entry orders provide the ability to realize profits and cut losses.
USING ENTRY ORDERS FOR STOP-LOSS AND LIMITS AFTER JULY 31, 2009:
For Buy Positions: Placing an entry order to sell below the price where you got into the position protects you from additional losses. Placing an entry order to sell above the price where you got in locks in profits.
For example, if you have a BUY EUR/USD position at 1.3900, you could place:
a stop-loss using a sell entry order (Stop Entry, SE) at 1.3800
OR
a limit using a sell entry order (Limit Entry, LE) at 1.4000.
For Sell Positions: Placing an entry order to buy above the price where you got in protects you from additional losses. Placing an entry order to buy below the price where you got in locks in profits.
For example, if you have a SELL EUR/USD position at 1.3900, you could place:
a stop-loss by using a buy entry order (Stop Entry, SE) at 1.4000
OR
a limit using a buy entry order (Limit Entry, LE) at 1.3800.
"The National Futures Association (NFA), which is the Forex industry's self regulatory organization in the United States, has informed all Forex Dealer Members (FDM) that it has adopted new Compliance Rule 2-43(b) regarding Forex trading. This rule requires orders be executed on a First In, First Out (FIFO) basis. FIFO requires that when multiple positions are held in the same currency pair, the position which was first opened will be the first to be closed. This will prevent stop-loss and limit orders from being placed on individual tickets (orders and positions).The NFA's stance is that FIFO provides more transparency to customers, offering a more accurate picture of the customer's overall profit and loss (P/L) than viewing the results of individual positions. The application of this rule brings the Forex market more in line with the practices of the Futures and equities markets.
FXCM has always encouraged active risk management through the use of stop-loss and limit orders. The stop and limit orders that have been available through the Open Positions window are two entry orders that are linked to an individual open position. If a stop or limit order is triggered, the other is canceled. FXCM has introduced a new feature called OCO (One Cancels the Other) entry orders, which will provide traders with the same functionality as they have been accustomed, except that they are not linked to any positions."
As a result of the changes beginning this month, anyone with a US Forex account should check to see how their broker is going to comply with the new rules, and what changes to the current method of order entries will be made, if any. It is assumed that every Forex broker has contacted their clients to advise them as to any changes by this time. However, if you have any questions or concerns after reading this article, the trader should contact their broker directly, and ask about Compliance Rule 2-43(b).
The NFA has a website that every Forex trader should visit for more information about their broker. Any Forex broker that is an NFA member has to meet high standards including a large minimum capital requirement to do business. Traders should check to see if their US Forex broker is an NFA member, and if they have any past customer complaints by doing a Background Affiliation Status Information Center (BASIC) search.
http://www.nfa.futures.org/basicnet/
The credit crisis of 2008 saw the failure of several large financial institutions. This became the US taxpayer's problem because of the fear that these large failures would bring down the entire world financial system. This exposed a major problem known as counter party risk – the risk that the underwriter in off balance sheet, unregulated, financial derivatives would not be able to pay claims. However, long before the financial problems in 2008, many Forex traders found out about counter party risk in unregulated markets. On October 17, 2005, Refco, Inc, at the time the largest futures broker in the US, filed for Chapter 11 bankruptcy protection after massive fraud was discovered by a newly hired controller a week earlier. The company had a retail Forex division among its 23 affiliates called Refco FX. The 15,000 customers of Refco FX had their accounts frozen immediately, and in December of 2006, a US bankruptcy court approved the company's plan to treat these retail Forex customers as general creditors with unsecured claims which were to receive between 23 cents to 37.5 cents. To this date, only one institution doing business in the US is offering customer protection of funds backed by FDIC insurance. None of the new regulations offer protection from counter party risk, so make sure you check out your broker. For an extensive Forex broker comparison website, look at FX Street's Brokers & FDMS.
http://www.fxstreet.com/brokers/
Your broker checks you out when you open an account. You should do the same.
Steve Misic - smisic@tradingacademy.com
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