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Hedging under new NFA regulation: FIFO (first-in, first-out) rule




NFA Rule 2-43(b)
The NFA recently enacted Rule 2-43(b) which effectively eliminates hedging by forcing brokers to close trades on a First In First Out (FIFO) basis. The NFA has added clarification to the rule, stating that customers can instruct their broker to off-set like sized positions.

Some traders have expressed concern that the rule will negatively impact their trading outside of the obvious limitation on hedging. The position of the author is, FIFO will add a layer of complexity but should not negatively impact a traders returns.

The Multiple Strategy Trade (Trades in the same direction):
It's not unusual for traders to engage in multiple strategies within the same account; at first glance the rule would appear to hinder any strategy who's trade had been opened first. Upon closer inspection this is not the case.

Sample EUR/USD Trades: (Prices are hypothetical)

Sample #1 – Pre FIFO

Trade # 1 Long Term Strategy (Long Trade)
Entry: 1.4287
Stop: 1.4000
Limit: 1.4500

Trade # 2 Short Term Strategy (Long Trade)
Entry: 1.4350
Stop: 1.4250
Limit: 1.4475

In this example Trade #2 hits its stop before Trade #1 hits its limit. Prior to FIFO Trade # 2's stop at 1.4250 would be applied directly to Trade #2.

Trade # 2 Net P/L is:
1.4250 – 1.4350 = -0.0100 (-100 Pips)

Trade #1 goes on to hit its limit at 1.4500

Trade #1 Net P/L is:
1.4500 – 1.4287 = 0.0213 (213 Pips)

Total P/L from both positions is 113 Pips.

Sample #2 – FIFO

Trade # 1 Long Term Strategy (Long Trade)
Entry: 1.4287
Stop: 1.4000
Limit: 1.4500

Trade # 2 Short Term Strategy (Long Trade)
Entry: 1.4350
Stop: 1.4250
Limit: 1.4475

In this example, Trade #2 hits its stop before Trade #1 hits its limit. According to FIFO, Trade # 1 must now be closed out first.

Trade #1 Net P/L is:
1.4250 – 1.4287 = -0.0037 (-37 Pips)

Depending on how brokers handle the remaining stop and limit orders, this will effectively leave Trade #2 with its original Limit but Trade #1's Stop.* Trade #1's Limit could also be in limbo here.

At this point, traders should now look at Trade #2 as a replacement for Trade #1 (Trade #1 became Trade #2 when Trade # 2's stop was hit). If Trade #2 is allowed to take the place of Trade #1 and hits its limit as in Sample #1 P/L is as follows.

Trade #2 Net P/L is:
1.4500 – 1.4350 = 0.0150 (150 Pips)

Total P/L from both positions is 113 Pips.

For this to work, traders MUST remove the original Trade #2 Limit of 1.4475, otherwise they will see Net Profit levels lower than the sum of the original (Pre-FIFO) trade setup.

Once traders work through this sample a couple of times the application of switching trades will become obvious and the implementation should be relatively straight forward.

* Please verify with your broker how stops will be handled on your platform. The new rule will effect OCO (one cancels other) and traders should not assume how remaining stops and limits will be applied. Application may vary from broker to broker.

Duplicating the Hedge

The NFA's position regarding hedging is that it provides no economic benefit; this is also the authors position. The new FIFO rule eliminates the ability of a trader to hedge positions, which has a secondary impact of preventing a trader to from using multiple strategies within the same account.

Despite the limitations, traders can effectively duplicate a hedging strategy and or multiple strategies in a single account by simply getting neutral (no open positions) whenever their model would signal a hedge or new opposing position is required.

In the samples below we review the impact of an open position on a hypothetical $100,000 account. Pips won or lost are assumed to be worth ten dollars per pip. The initial position is assumed to be a Long EUR/USD entry, no adjustment for transactional impact (spread) is made.

Sample #1 – Baseline: Trades are not hedged and the position is left open through the balance of the price action.

Hedging under new NFA rule

Sample #2 – Hedged: Trades are hedged towards the end of the price action sample.

Hedging under new NFA rule

Sample #3 – Neutral: Trades are closed out when a hedge or opposing position is required.

Hedging under new NFA rule

When a trader's model would signal the end of a hedge or opposing position, they would simply reenter the market at the current price. It should be noted that this approach does not induce higher transaction costs and may actually reduce roll-over impacts that tend to favor the broker.

by John Putman II FXstreet.com

Any alternative option for traders who want to continue hedging with NFA regulated broker?

Yes, it requires opening 2 accounts with either the same broker or two different brokers. This way traders will be able to Sell currencies on one account and simultaneously Buy currencies on another, achieving same hedging effect.
There is a factor to keep in mind: traders would need to monitor the health of both trading accounts and transfer funds in time from a growing account into a shrinking one in order to balance profits and losses and avoid margin calls.



Broker discussion area

trader

March 6, 2017

It’s been a nightmare since this so called Dodd-Frank bill was signed. While it's intentions were probably legit, such notions that the government wants to keep you from hurting yourself as a investor/trader is absurd. After all, big brother knows what's best for you, right?

While FIFO may work on traditional escalators that require an orderly transition from point "A" to point "B"- but in reality, markets work more like elevators going up and down, true? This rule should only be imposed on government buildings with more than 20 floors where it belongs, and not in the capital markets. Hope president Trump repeals at least this part of this egregious rule.

Only the so called "regulated brokers", love this 50:1 max leverage rule and will tell you that the "real pros" wouldn't complain. However in reality this is merely a ploy to force investors to initially send more money to the brokers. The rich get richer while the retail investor pay the fees, so the big guys can trade for you. Hey it's better than the bank CD, right?

The no hedging rule just makes it so much easier for brokers to pluck off your stop loss. The brokers will tell you that a work around is opening 2 accounts so that your strategy can work on different time frames. Just send more money. So if your strategy buys from a signal on the 4 hour chart and sells on the daily chart, but only if you are rich enough to have multiple accounts.


trader

September 9, 2016

The problems with opening an fx account abroad is that most of them do not offer cc and that is scary because banks do not offer e commerce or merchant account to business not deemed qualified./verified/ financially sound. Also some only accept EU cc.

We should all get together and file a lawsuit against NFA as NFA is nothing but a MAFIA.

If anyone knows of a broker who accept us cc. please email me

infojunky@safe-mail.net

Thank you very much


trader

August 6, 2016

NFA = "NON SENSE FOREX ASSOCIATION"


trader

April 27, 2016

Hey Americans,
Please do something to get this rule taken back. Get the forex rolled back.


trader

December 14, 2014

***k ** OBAMA.


trader

May 9, 2012

ATC and FXDD allow Metatrader 4 to run older EA that hedge with a Back office Solution. I am looking for other brokers that do that.

Also, the problem with trade copiers from professional trader outside US that hedge.


BrokerGuru

April 30, 2012

The FIFO rule applies to all Forex brokers in the United States.
Since US citizens are allowed to open Forex accounts only with US brokers (according to NFA rules), yes, you can say that FIFO rule is for people in the USA.


trader

April 27, 2012

Is this fifo rules made for pple in the usa


trader

March 12, 2012

The writer of this article is a moron. The new rules have crippled my forex trading. They have cut my profits by 65%. I believe they are also unconstitutional in our supposed "free" society. Let's say you buy a car, and then buy another car exactly the same, a month later. Wouldn't you consider it rediculous for the government to tell you that you have to sell the first car first, before they "allow" you to sell the car you bought second. They have no right to do that. You are not hurting or misleading anyone. The new rules are illegal and unconstitutional in a supposed free society.


trader

January 19, 2012

If you want to Hedge on MT5 have 2 client terminals in 2 family names, set up both with pending orders, 1 terminal will buy the other will sell


trader

May 27, 2011

This angers me so much. Its getting harder and harder to make a profit doing anything in the US. I'm now committed to giving up my US citizenship and moving abroad, just so I can make a living at trading, I'm not going to do it immediately but look into it first to see the best way.

Once out, I can open a corp in a tax free country, like the Cayman Islands. Then I can make profits from my US profits tax free, legally. Why, because little do people know but foreigners are not taxed on profits made in US by USA. I'm not talking about green card wage earners, I'm talking about foreign investments in the US.

As you all said, this person does not consider commissions, nor the impact of introducing complexity. I think this guy was also paid to write this article.

This world is so scary, how governments and the super wealthy who control them, have used computer technology to come up with these regulations to track everything we do and extract as much as possible.

Now see why our own citizen's like Timothy Mcveigh are fighting the feds. Before, I though what he did was lame, but now I see its a war for true life, liberty and the pursuit of happiness. It's going to get a lot worse before it gets better.


jensen

May 1, 2011

Years ago I traded currencies and I was presently considering opening an account again when I noticed these "FIFO" rules were put in place. As a US citizen there is ABSOLUTELY NO WAY I would open an account having to adhere to these FIFO rules so my business has been lost. I wonder how many others feel the same way as me. If anyone out there has a solution to getting around FIFO rules please contact me at jensen.g.k@gmail.com


trader

February 27, 2011

Way too many self-professed "professional traders" who announce themselves as such on forums and blogs make me laugh when time and time again, they prove that they are not professional traders. If they were professional traders, especially professional and very profitable scalpers, they would spit on NFA's rulings. Professional traders should trade the opportunities rather than sit on an open position and let it ride for 2 weeks or more. If this is how you trade, yeah, then I guess FIFO is great. But it sucks for professional scamper traders who are and were very profitable and efficient. They along with me, trade opportunities. And opportunities present itself at various moments... minute to minute and seconds to seconds. Now, brokers will handle FIFO rules differently but scalpers will now establish offshore addresses and go there instead rather than attempt to deal with US based and NFA regulated brokers. I am still shocked and dismayed that so many so called experienced traders don't understand what hedging really is.


mp

February 13, 2011

The U.S. Regulators have driven investors offshore once again...

The next thing will be a additional special tax on profits made from forex trades for individual U.S. traders.
LOL..

TRADER --- dont laugh, because the tax is being sent for voting as i write this, and yes, the good traders are offshore cause there is no place here for them and yes, it was a sweetheart deal between the brokers and the NFA once again, just as the SEC works for the market makers and not the retail traders.

You done hit the nail right on the head, and hard !

mp


trader

February 13, 2011

I must strongly disagree with the author on his/her position of hedging holding NO advantage, although I would refer the trading I speak of to be COUNTER TRADING -- we have all seen a price moving up towards a most definite TP point, but of course in the meantime, the price stops moving and starts dropping, allowing for either averaging down your position or actually TAKING the short trade

Now I do both, and the current rules in the USA (but fortunately not with the Swiss) prevent that ---- HEDGING, per se, although it controls margin in a positive manner, is prob the least favorable method of trading, based on "guessing" as it is, and NOT knowing, and so I have no real feelings concerning that, but to eliminate the advantage of counter trading in one account (if you hold a long and a short, the margin never moves) and the SPEED of being able to enter the trade, opposed to finding the right trading platform, remembering what you intend to do, and then having to go to the other trading platform to now enter the "averaged down" long trade is a royal pain in the maximus glutimous !

So, being a simple person who accumulates a very decent number of pips in a day, the Swiss strike me as remaining true to their national heritage, and that aint chocolate or cookoo clocks --- its MONEY !

Maybe newbs dont need the ability to counter trade, move VERY fast and trade the 30 second charts, but any scalper heading for a minimum of 600 pips a day MUST have that ability.

enjoy and trade well

mp


trader

July 20, 2010

Almost looks like the big brokers and banks paid the NFA to pass the regulation.

Then paid the developers of MT4 to make strategic trading on MT5 impossible.

All NFA regulated brokers will have to use MT5.

Well I guess theres one thing to say about that...

The U.S. Regulators have driven investors offshore once again...

The next thing will be a additional special tax on profits made from forex trades for individual U.S. traders.
LOL..


trader

February 28, 2010

What all experienced Forex traders know is that constantly having to exit and re-enter trades in the same direction is costly, both in terms of spread loss and commission. (And if you're not paying commission, but using a spread profit i.e. "bookie" broker, you're not an experienced trader.) The above analysis doesn't take into account spreads or commissions. The NFA rules now make your cost of trading higher. Say there's a nice long trend, and you're in with Trade#1. But you spot a potential turn. If you just keep your long trade it, and hedge short, and your hedge stops out, then your long positions just continues. That's just two trades. With the new rules, there would be 3 trades. Addtionally, you have spread loss now, for the additional re-entry trade. In summary, the NFA FIFO rule assumes an ideal trading model, where there are no commissions and spreads, and that isn't the real world of trading. Commissions and spreads KILL YOUR PROFIT if you have to enter/exit/re-enter good trades.


trader

December 31, 2009

For those of you MT4 users who don't know it yet: The new MetaTrader 5 platform allows only one position on a specific currency pair and it's a complete NFA FIFO compliant. The MT5 will always close oldest trades first - multi-positions strategies will be no longer possible. This is not acceptable for me and even though I got used to MT4 and it's custom indicators and helpers I wrote myself, I will have to move to a broker who offers a platform, where I can manage my trades as I need. Even my russian broker which is not NFA regulated will switch to MT5 soon and force me to either accept the completely ridiculous FIFO rule or find a broker who allows multi-position trading without FIFO. If other countries on the world adopt similar regulations, then Im out of the business because I will not be able to freely decide what and when to buy or sell. Which is not a regulation but a violation of the very basic principles of trade.


trader

December 15, 2009

Pointless regulation that is sending me to search for brokers that do allow hedging. I will be doing business with non NFA regulated brokerage houses.


trader

July 18, 2009

The NFA is a nasty regime imposing worthless regualtions on us. They can F-off and leave us alone as far as I'm concerned. They are simply trying to get rid of forex traders so that the futires traders know where all the actual volume is.



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