The NFA Shakes the Foundations of Forex Trading

DailyForex.com Team

-Hillel Fuld
If you are even remotely involved in the Forex market, you have most likely heard of the new NFA First in First Out (FIFO) rule. It is the most talked about topic in the online and offline Forex worlds.

The NFA

First let's give a little background as to what exactly this ruling is, then we can discuss how it will affect the Forex market. The NFA ruled that as of August 2nd, 2009, when a trader opens more than one position in the same currency (for hedging purposes for example, but we will talk about that later), the trader must then close the positions in the order they were opened. If he/she opened a trade for $100,000 in the EUR/USD currency for example, then continued to open other positions in the EUR/USD currency, that first position needs to be closed before any subsequent positions he/she opened are closed.

There are many differing opinions circulating as to whether this is a positive or negative ruling when it comes to Forex brokers and traders, but one thing is for sure, it will drastically change the Forex game.

Forex Platforms

How so? For starters, as you know, all of Forex trading is implemented using Forex trading platforms. Each broker has a trading platform that they customize to meet their traders' needs. With this new ruling in effect, the trading platforms have to make numerous changes in terms of what is allowed and prohibited. Take for example the Close button that now appears adjacent to each open trade. After August 2nd, that button will only appear next to the first open trade, and will not be available next to trades that were open later. 

All those “cosmetic” changes is not what has the Forex world on their feet. What people are really trying to digest is the effect this new FIFO ruling will have on the existing practices of trading used by traders all around the world. Take Forex hedging as an example. Many traders see hedging as an insurance policy for their Forex trading. 


Forex Hedging?

To understand this concept, it is easiest to use a concrete example. Let's say I decide I want to buy $100,000 of USD/JPY. Naturally, that is accompanied by a huge amount of risk. So how do I minimize my risk? How do I insure myself for the worst case scenario? Quite simple, I open another position in which I am selling the same $100,000 of the same currency. Then what I go ahead and do is place a stop loss of 10 pips on each and a take profit of 50 on each. If the market moves one way, the stop loss will close off the position that triggers it, whichever it may be, and the other will continue to make me some nice profits.

This is a very accepted practice and some people will claim that both the trader, who insures him/herself, and the broker who makes profit on every open position can benefit from hedging. However, with the new FIFO ruling, this scenario would not work. The position I opened first, no matter the direction which the market turned, will need to be closed before my second position is closed. Hedging will no longer work.

I have spent countless hours researching this topic and I would say that the opinions on this ruling are split down the middle. Some people think it is a wonderful thing, since hedging, in reality, is a fictional move. Think about it. Imagine going to a money changer and asking him to sell $100,000, then once he does that, asking him to buy $100,000. I am pretty sure he would think you are nuts. This would obviously leave you at level ground and cancel each other out. The fact that this is an accepted practice in Forex trading does not say good things about the Forex market and its standards.

S
ome people will claim that hedging is not a legitimate way of trading Forex. Not only that but they will also claim that another benefit of this new ruling is that the Forex market is now at level ground with other markets such as equities, futures and options. 

Forex Volatility

On the other side of the debate are traders who will tell you that with the volatility of the Forex market, they depend on hedging to guarantee minimal losses and use stop losses and take profits as their primary management tools in their day to day Forex trading. These traders are of course highly dissatisfied with this new ruling.

This is an extremely heated topic in the Forex world and some experts claim that the NFA have made a tremendous mistake with this ruling that will affect the whole of the Forex market as well as the credibility of the NFA as a Forex regulator.

Now that we established that FIFO will have a tremendous effect on Forex traders, the first question that comes to mind is, how will it affect Forex brokers? The answer is Forex brokers are now presented with two possible options. They can either work around the clock to adapt their trading platforms, practices, and rules to meet the new trading standards or they can work around them.

If they choose the first path, they will need to remove the Close button from all trades opened in a currency after one initial open position. They will need to disable any hedging options among their traders, and make other cosmetic and significant adjustments to their website, terms of service, and trading platforms.

The other option is of course to send their customers to trade with brokers that are not regulated by the NFA, and are thereby not bound by the new FIFO ruling. This means of course brokers that are outside of the United States. This is of course not the ideal solution, nor is it what the NFA had in mind when issuing this new rule. As of now, as far as we know, it is a legal move, but it would not surprise me if the NFA would work on preventing such a phenomenon.

NFA FIFO

The bottom line is the NFA made a revolutionary and some will say scandalous decision with their new FIFO ruling. There is now a big question mark surrounding the future decisions of Forex traders and brokers in the United States. Are traders going to now search for new brokers abroad or are they going to stick with their current brokers? Are the brokers going to spend the time and money tweaking their existing trading infrastructure or are they going to take the easy way out and redirect their traders to other brokers abroad?

The answers to these questions will only be determined months and even years after the FIFO launch date of August 2nd, 2009.

About the Author
DailyForex.com Team
The DailyForex.com team is comprised of analysts and researchers from around the world who watch the market throughout the day to provide you with unique perspectives and helpful analysis that can help improve your Forex trading.
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5 User comments
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xxx
2009-07-26 19:07:35Z

Tyro: Did you not read Hillel's description? A SL and TP are placed on each position so that when the price breaks out the hedge is removed. So there are "clearly mapped regions where these win or lose". Now, of course, some dealers will be adding OCO orders to allow the same kind of strategy. But that's still not quite the same as hedging.
It's irrelevant if it's the same security or not, as I attempted to explain with my FAS/FAZ, SSO/SDS example. These are funds that are explicitly designed to be inverses of each other - very high negative correlation. So, nobody can say that this type of trading isn't or can't be done in other markets.

The one thing people tend forget when discussing this NFA ruling is that instead of simply putting a stop to the dealer practice of charging twice the spread including interest to hold offsetting positions, they decided to change the nature of the market itself. Without any public discussion whatsoever.

Tyro
2009-07-26 17:07:51Z

"Tell that to anyone who makes money by buying a straddle or strangle."

Totally different case - these options traders are buying and selling different securities and there are clearly mapped regions where these win or lose. With the Forex case, you're buying and selling *the same* security, have zero market exposure and aren't hedged so much as absent.

xxx
2009-07-26 13:21:06Z

You say: "hedging, in reality, is a fictional move". Tell that to anyone who makes money by buying a straddle or strangle. Or what about the common practice of buying the Long and Inverse ETFs at the same time (FAS/FAZ, SSO/SDS etc..)?

It's not "nuts", it's called risk management. This ruling is based on nothing more than the personal beliefs of someone high up in the NFA. It was not made through consensus, consultation or open discussion.

Hillel
2009-07-26 00:23:37Z

From what I understand, there will be no more hedging allowed in the Forex market.Thanks for reading...

jan
2009-07-25 21:10:18Z

what about hedging on different platform?

wil that be allowed?


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Please make sure your comments are appropriate and that they do not promote services or products, political parties, campaign material or ballot propositions. Comments that contain abusive, vulgar, offensive, threatening or harassing language, or personal attacks of any kind will be deleted. Comments including inappropriate will also be removed.

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