Forex Rules

The retail trader is a phenomenon inherent since the early 1990s. Traditionally, traders were a small group of people who worked in the industry, trained by university education, or taught by an industry insider. The use of indicators as a means to make trading decisions was primitive but gained favor along with the retail trading public. Along came the personal computer, which revolutionized trading. So trading any financial instrument became democratized for young and old, educated or not, industry experience or novice. All that was required was a computer, investment money, and the ability to learn.

Along with this phenomenon and a growing interest to learn came training schools, trading systems, and firms to handle this growing interest. Traders were taught how to place orders to hedge, stop-loss orders, limit orders, closing and opening positions, and the use of many modern indicators that arose with the computer.

Many learned how to profit from these methods. We have all grown accustomed to this way of doing business since the early 1990s. Now, the NFA has turned this method of trading on its head with new rules that govern trading, particularly currency trading.

Next came Rule 2-43b, the elimination of stop-loss, trailing stops, and limit orders, effective August 1. No longer can positions be closed by simply hitting the close button. Instead, positions must be closed by an OCO order, an offsetting position.

Finally, Rule 2-43b instituted FIFO (first in, first out). This means no matter how many lots a trader may have or how many points of profit, the first lot must be addressed first before dealing with the remaining lots.

HEDGING AND ITS IMPLICATIONS
Why is hedging so important to traders? Suppose a major economic announcement will be released imminently and you as the trader do not know which way the announcement will go based on expectations. So you implement a long and short in the same currency pair. Once the announcement is released, say your pair takes off long. So you bail out of your short and ride your long position for a profit. If the economic release was out of sync with your expectations, you may be able to hold both positions at the same time and profit both ways. I have done this countless times.

Suppose you are a swing trader and hold positions for long periods. You note that on one particular day, your long position will suffer an outside day so you take on a short position to hold and profit for the day. Suppose you entered a long trade and realized you entered at the wrong point but you know the trade is a good long. Your trade position goes down so you go short to not miss the points and wait for your long positions to come back and profit.

Suppose the British pound/US dollar (GBP/USD) approaches resistance or support, but it does not appear it will break at that moment, so you hedge your position and profit. Suppose the euro/US dollar (EUR/USD) is trading at the middle of its range and you want to take a position but are unsure of the direction. You hedge your position. Every point of movement can be a gain, with hedging especially for scalpers.

But hedging is no longer allowed in the same currency pair under Rule 2-43b. The NFA's argument is that hedging increases fees for the firm and has no economic benefit for the trader. The solution is to go long and short using two different accounts. The NFA also argues that hedging creates rollover interest for firms.

As an aside, much speculation exists that oil traders will undergo the same fate to eliminate hedging. Commodity Futures Trading Commission Rule 74 FR 23964 took the hedging function away from noncommercial swap traders and replaced it with "limited risk management." Sophisticated traders would know hedging as a limit and a stop-loss with prices placed at different intervals.

Stop-loss orders are geared for traders who don't scalp or sit in front of the computer all day. Normally, these traders are market savvy. They know where the market is going but realize events of any trading day may disrupt their profit potential. So they set a stop-loss, a point of loss they are willing to lose on a trade, in case a position goes against them. Many use trailing stops, especially when profits are built into your trade. As the market goes against you, your trailing-stop hits and you can realize your profits. Stop-loss orders are not allowed anymore, according to Rule 2-43b.

LIMIT ORDERS
How far are you willing to ride your trade and how much profit do you want to earn? You need to answer this question so you can set your limits on your computer. Again, this is a function for sophisticated traders who know their market and currency pairs so they don't have to wait to exit their trade manually. However, limit orders are increasingly used by traders of all sorts since this market has become more and more popular. It is not allowed under Rule 2-43b as of August 1, 2009.

CLOSE-OUT TRADES
If you are not using an automated trading system and wish to manually close out a trade, all you have to do is click the sell or close button to exit your trade and take your profits or sustain your loses. This is no longer allowed under Rule 2-43b beginning August 1, 2009. Instead, "one cancels the other" (OCO) orders will be instituted to enter and exit the market. The reason for OCO orders is because of the last NFA rule called FIFO: First in, first out.

Now, suppose you have a buy order for one lot on the GBP/USD at 4800. Say your trade drops to 4700 and you place another buy order. An hour later, your 4700 position is 4750 on your second lot. You can't exit your trade with a 50-pip profit because you must first address the first lot. You can't take your profits because you still have a loss on the first lot. When the first position is resolved, you may then take your profits. First opened must be the first closed.

So, why the revolution and why are currency markets affected? The answer is twofold. The number of complaints and enforcement actions investigated and ruled upon by the NFA and the CFTC against currency trading firms is enormous. Many firms don't register with FINRA or the NFA, others don't segregate their accounts, others violate antimoney laundering laws and bank secrecy acts, some charge enormous spreads, and principals just disappear with their firm's money, while others rig the main trading computer. The list and complaints are endless. Since currency trading is traded in the over-the-counter market, a certain "buyer-beware" scenario must be evident because of the unregulated nature of this market.

It is also explicit in the writings of the NFA and CFTC that the public is just not sophisticated enough to understand such complicated financial instruments, nor can they have the capacity to trade and profit from such instruments. So "protect thy customer" rules were instituted. But only in the US do these rules apply. While legitimate firms have abided by many new and various policies such as increased capital requirements, prompt account statements, and frequent audits, actions by NFA still follow under the customer-protection rule. Yet the NFA knows from their prior explicit communication and policy statements that regulating the market is impossible, so why not regulate traders? So can the regulating authorities treat the currency market as a regulated futures market by instituting orders similar to futures orders? Can they eliminate the profit motive and drive traders away from the business of trading currencies? That remains to be seen.

What these rules mean for firms is a complete retooling of their computer systems, and that will take time. Increasing the capital requirement for firms may help drive out the many corrupters of the industry and give the respectable firms the name they deserve.

Trading system designers must retool their systems as well to comply with new rules. Training schools will have to teach new methods of trading.

One aspect of the currency markets is prices never remain the same for any length of time. At times these markets will look chaotic to the novice because of the fast movement of prices. But it is this fast movement of prices that gives the currency markets their organization. It is what gives traders the ability to profit from price discovery. A true method exists for traders to profit. Now, more than ever, traders need to be educated so they learn these markets, indicators, various currency pairs and how they move, and the mechanical aspects of this market.