New NFA Rules and what they mean to you

[Pharaoh]

The NFA Giveth and the NFA Taketh Away
by Pharaoh
​

By now, you've probably begun to hear about the new anti-hedging regulation the NFA is about to impose. This can be pretty inconvenient for some trading styles, but don't be ready to move all of your money offshore yet. The NFA also gave traders a HUGE benefit as part of the same new regulations.

First, let's get the bad stuff out of the way.

As of May 15th, 2009, hedging won't be allowed on NFA registered brokerages. What this means is that you won't be able to have any new long and short positions on the same currency pair at the same time. Not all brokerages permitted this, but hedging ability is standard for MT4 accounts and does work with other forex trading platforms.

Usually, to open a long and a short on the same pair is silly, but there are legitimate reasons to do this. Some EAs us a hedging strategy. Some traders (myself included) might have long term positions in one direction and want to take short term trades in the opposite direction while letting the long term trades run. Also, when a trader has been foolish enough to let a position run far against him with no stoploss, opening a hedged position locks in the loss to that level, giving the trader time to contemplate the unpleasant choices left available (at least until swap fees or widened spreads finally eat all remaining available margin). Just to be generous, they announced this on the 13th of April so that those of us who hedge would have month to adjust our strategies. Nice to know that they expect people to be able to take strategies developed over months or years and adjust them in only 1 month.

For those who want to hedge, there are several options. At least 1 brokerage is trying to determine if hedging can be done intra-day and that opposing positions will only automatically close at rollover time. Other brokerages that have licensed offices both inside and outside the USA are allowing US clients the option of moving to one of their offshore branches.

Another choice would be to open a second account at your brokerage and place your hedges in the other account. For those who like to leave long term trades open while making short term trades, this would work well. For someone trying to buy time to think of options during severe drawdown, it would fail. For forex robots that hedge, it would fail.

Other options are “synthetic hedges”. This would involve opening trades on related, but not identical pairs. The EUR/USD and GBP/USD tend to move in the same general direction much of the time, so if you wanted to trade opposite of a EUR/USD long, you could open a GBP/USD short. The EUR/USD and USD/CHF are inversely correlated, so if you wanted to hedge a EUR/USD long, you could open a USD/CHF long. Forex trading robots that hedge normally would need to be reprogrammed for this to work.

I contacted several brokerages and asked them a simple question. If I have a long position on the EUR/USD and try to open an equal sized short position, what happens? The possibilities are: 1. It won't let me open a short position. 2. The positions will cancel out, thus closing my long trade. 3. Positions will open, but will cause close outs at rollover time. None of the brokerages were sure, but said that they would have answers soon – I hope before May 15th. Judging from the lack of solid answers from the brokerages, this was definitely not their idea and they are scrambling to find ways to deal with it.

Assuming trades are forced to be closed (instantly or at rollover), the rule seems to be FIFO – first in, first out. Thus, if you open a 0.8 lot long on the EUR/USD, then a 0.5 lot long on the EUR/USD, opening a 0.5 lot short on the EUR/USD will close 0.5 lot of the first 0.8 lot EUR/USD long that you opened.

Why did the NFA do this? My personal theory is that they accidentally took the wrong medications one morning, but they do claim to have had some real reasons. For inexperienced traders, a broker might encourage hedging just to collect more spread. An unscrupulous account manager could open hedged positions and later close the half that was in profit to show profits (at least for clients who are not bright enough to ask about currently open positions) and collect performance fees. Some people might be stupid enough to leave hedged positions open for long periods while the swap fees eat their remaining account balance.

Overall, I find these reasons to be very inadequate. Truly stupid traders will find a way to get margin called very quickly without the NFA messing with those who have legitimate reasons to open opposing positions. Some people need training wheels to learn to ride a bicycle, but this is the same as forcing all of us to have training wheels on forever for the sake of a few perpetually unbalanced people. The sad part it that in this time of economic upheaval, I'm sure this will cause a number of traders to move their accounts to offshore brokerages. Very likely, some of these brokers will scam the traders out of their money. Also, some US brokerages will end up hiring fewer workers or laying off workers because of reduced business volume. Way to go NFA! Save a tiny amount of money for a few people and end up costing jobs and making others move their money out of the country to banks and brokerages that are at least potentially riskier.

So, for those of you who want to get in touch with the NFA and throw a screaming fit, here's their contact info:

Email: information@nfa.futures.org

Chicago Headquarters
300 S. Riverside Plaza, #1800
Chicago, IL 60606-6615
(312) 781-1300
(312) 781-1467 (fax)

New York Office
120 Broadway, #1125
New York, NY 10271
(212) 608-8660
(212) 964-3913 (fax)


OK, now that I've told you about the truly moronic part of the recent decision, let me tell you the good part. While one group of NFA regulators was exploring the deeper recesses of bureaucratic stupidity, some brilliant crusader for traders' rights slipped in the BEST RULE EVER!!!!

Many traders have experienced the ripoff where a brokerage waits days (or weeks or even months) to say “We're sorry, but there was a price feed error, so 40 pips of your 50 pips profit are gone.” As of June 12th, 2009, that semi-legal form of theft ends for good with NFA registered brokers.

For positions established after June 12th, brokers are greatly restricted from making price adjustments to client orders. There are only 2 exceptions.

First, if a customer disputes a price, adjustments may be made, but ONLY in the customer's favor.

Second, if the broker has an exclusively straight-through processing model and the liquidity provide makes a price adjustment. In these cases, the customer must be notified within 15 minutes. Yes, that is 15 minutes from the order being executed to send a notification to the customer. Save those emails with full headers – you may need them to prove that they waited 20 minutes to notify you. If the broker isn't exclusively STP, then they don't even get 15 minutes.

As for spike trading and broker rules – I really am not sure how this will work with a non-STP broker. They won't be able to adjust the price. I have a feeling we may see some interesting legal cases starting in late June.


For those of you contacting the NFA to complain about the hedging rule, make sure to take a moment to thank them for the new protection they've given to traders to keep brokers from being able to make up prices later. Maybe this will drive some business back to US brokerages.

I'd like to give a special thanks to my fellow FPA member G3flyer for posting some more details in FPA's forums. I was already working on this article, but the PDF file he posted from the CFTC and NFA filled in a lot of details about what motivated these changes.

New NFA Rules on Hedging and Price Adjustments

 

[yurps]

wow, that means no NFA broker will fill you on the news anymore....

This is the next step of regulating the wild west of forex...the same thing happened to futures, personally I think the odds are against the retail trader
in forex, unless your strategy is about taking advantage of price discrepencies. If so you better take advantage as much as you can now.

 

[synaesthetique]

While I like your accidental medication theory, I suspect that we can all thank one person for this anti-hedging policy: Bernie Madoff. He was known to have nedged (aka: newb hedging or flat position - a real hedge is between two different instruments so I call this rule the nedging rule) in order to give the appearance of being in the market.

One bad apple ruins the bunch

 

[SRK]

The net overall sounds like good news!

Now, what about the capital requirements changes especially with ECN brokers like MBT? What happens to client accounts and funds at brokers that don't meet the capital requirements by the deadline?

 

[hanover]

Workaround to alleviate the anti-hedging rule

Hedged orders can be replicated easily enough, if one realizes that it's the overall net position (long or short) that's ultimately significant, at any point. For example, if you're simultaneously net long 1 lot, and net short 1 lot, then you're effectively out of the market.

Taking this into consideration, here's my proposed alternative:

-- If price reaches a point where your hedging strategy requires you to either open a long position, or close a short position (e.g. TP or SL reached), then you would first close off any currently open short positions (in full or in part) for the required number of units, and then if you still don't have enough short units to meet the requirement, open a long position for the remainder.

-- If price reaches a point where your hedging strategy requires you to either open a short position, or close a long position (e.g. TP or SL reached), then you would first close off any currently open long positions (in full or in part) for the required number of units, and then if you still don't have enough long units to meet the requirement, open a short position for the remainder.

In this way, you're only ever long or short in a currency pair, and will gain (or lose) exactly the same number of pips as you would have using hedged positions.

Of course this isn't as convenient as being able to create pending orders with TPs and/or SLs, and then walk away. But if your trading platform (e.g. MetaTrader4 or TradeStation) has programming facilities, then it would easily be possible to write an EA to automate this.

There are also some cost benefits (efficiencies) in minimizing the number of open positions. The first involves rollover interest (swap). Brokers tend to charge more interest than they pay out, so it's better to be out of the market altogether than to have hedged positions. Another possibility is the scenario where the hedged trader gets trapped with unproductive offsetting orders, and he wishes to close both of them (rather than pay the recurring daily interest). Hence he must pay the spread on these orders, that would not have been incurred if he had simply been out of the market. The workaround that I described will never result in paying more spread than an equivalent hedging methodology, and there are situations where it results in paying less.

The bottom line is that, to be profitable trader, you must be net long heavily/frequently enough, while prices are rising, and/or net short heavily/frequently enough, while prices are falling, to overcome costs. Orders are ultimately nothing more than a vehicle for adjusting your net position. Hence it doesn't matter whether you're entering or exiting, using TPs or SLs, scaling in or out, hedging, using market or pending orders, ..... whatever. There is no money management system, that in itself, provides a winning edge. Ultimately it's how you accurately you time your position adjustments around market reversals, on balance, that determines your base P/L.

 

[bamcoti]

NFA

As a EA user that takes advantage of hedging I have already been complaining. My most profitable EA hedges and martingales both ways at the same time the margin usage is only half of running the two opposing strategies separately. It closes baskets of trades by monitoring the equity. Then the other issue the NFA is pushing here is the swap. This EA also closes the negative swap trades when in profit and lets the positive swap side run over night or through the week ends. I also have other EAs that trade on the same pairs. They do not hedge but different strategies might take opposing position. One might be a long term player while the other is scalping in the opposite direction. FXDD, although not yet NFA registered will probibly go along with the new rule so as not to nullify their efforts to be NFA registered. They have made no anouncment to their clients yet. They do not want them all to flock away until they have some way around this. They have their best minds and programmers working on this issue. One possible way to trade this might be with a modified MT4 Multi Account Manager running on a demo account controlling two live accounts. Longs go to one account and shorts go to another. The accounts are some how automatically equalized. No one knows if MT4 can get this to work before the deadline. I suggest that every one complain to the NFA. The squeaky wheel get the lube. It is like having your rights taken away. I do not think they truly want to protect any one and that this is just the excuse they are using. I believe they are doing this to try to migrate every away from spot forex and to currency futures. You see they do not get paid on the spot forex side but the NFA gets paid a percentage of every futures trade. There is a big problem with this. There is almost no liquidity in the currency futures at this time and the leverage is very low. Thus there is not much profit for a retail trader.
complain!!!
Mike

 

[Herringtrader]

Could anyone please show me a list of all the NFA regulated brokers?

 

[Mr. Madruga]

non-STP broker will probably double their stop hunting acts to recover money from those cases you mentioned.
why not dont allow brokers to have conflict of interest with their clients? that would be the best regulamentation ever...

 

[Cyclon]

Thank you

Thanks, Pharaoh for the nice layout of the new regs.

Cheers,
Cyclon

 

[sanyhuis]

sanyhuis

Does anyone want to comment on the new leverage rules that are coming up from the NFA? Limit of 100:1 for majors and 25:1 for all others.

Also, as a footnote, I tried to transfer funds yesterday from FXCM to FXDD and FXCM wouldn't do it because FXDD was not regulated.