Wednesday, July 22, 2009

What You Need to Know To Prepare Now…

Also In Today’s Letter…

• Part I: You Can’t Play Both Sides Anymore
• Part II: Close Out the First Trade First
• Europe Headed for a Fall…Another “Anti-Green Shoots” Story

By Sean Hyman I must say, I’m not thrilled with the NFA right now.

In just 10 short days, the National Futures Association (NFA) will change the rules affecting your Forex account and how your Forex firm handles your trades. And they’re causing all kinds of headaches in the process.

So what the heck is going on with the National Futures Association (NFA) and why are they shaking things up at the Forex firms?

In short, they believe that Forex orders should mimic orders in the stock or commodities market. In other words, they think all orders should be (FIFO) First In, First Out.

This new rule is officially NFA Compliance Rule 2-43(b), but traders have already nicknamed it the “FIFO rule.”

The NFA has stated this New Compliance Rule 2-43(b) requires an FDM (read: Forex dealer) to offset positions in a customer account on a first-in, first-out basis. The goal? The NFA wants to stop a trading practice commonly known as “hedging.”

Now, the important part…how does this all affect you and your account?

Part I: You Can’t Play Both Sides Anymore…
According to the NFA

If you are with a U.S. regulated firm, then the NFA rule stands.

You won’t be able to “hedge” an order anymore. Hedging is when you are both long and short the same position. For example, up until now, you’ve been able to buy and sell the EUR/USD at the same time.

Personally, I never used this option anyway because if you’re wrong in a trade, you’re only delaying the inevitable loss. You’re also paying more in rollover as the market proves you even more wrong.

Pros never delay losses, they take them quickly. Novices delay them because it just kills them to be wrong. A pro knows that being “wrong some of the time” is just part of the territory.

So it won’t hurt my feelings to see this part go. But if this part of your overall strategy, there is one thing you can do. I’ll get to that in a moment.

Part II: You Must Close Out the First Trade First

The fact that you can’t play both sides of a trade is only half the story. There’s a second part to this new FIFO rule.

The new rule also says that you have to close out the FIRST order that you placed FIRST. So you can’t “pick and choose” which orders you want to close out. You have to close out the first position of any multiple positions you have in a particular currency pair, no matter whether it’s a gain or a loss.

Now keep in mind, if you’re a retail trader, and you only place one currency trade at a time on a particular currency pair, then this rule won’t affect you much.

For example, say you’re bullish on the euro and yen. So you place a trade on the EUR/USD…and then later in the week decide to short the USD/JPY. You could still conceivably close out the USD/JPY trade first.

The only problem comes when you want to place multiple trades on the EUR/USD or USD/JPY…then you have to close them out in the order you placed the trades on each pair.

Many Forex firms are now scrambling to comply with these “quick” changes from the NFA. Their FX trading platforms generally weren’t coded for FIFO but rather to give the client choices about which orders they wanted to close out instead.

But that’s your Forex firm. Let’s talk about how this affects you…

You Can Still Place Stops & Limits, Just in Different Ways

So does this mean you can no longer place stop and limit orders?

NO! You absolutely CAN place stop and limit orders. Firms just have to change how this process works at present. Many firms are having you offset your order with opposing entry orders.

For instance, if I bought one lot of EUR/USD at 1.40 I could place a sell entry at 1.39 and a sell entry at 1.41. The one at 1.39 would close me out if I was wrong in the trade (a stop) and the other would close me out if I were right in the trade (at 1.41 and work as a limit order).

SO STOPS & LIMITS STILL EXIST. That’s the important part to remember. Just the way that they are entered is changing.

In fact, some of these firms have already made OCO orders (One Cancels the Other). That way, if your limit hits, the entry acts as your stop to cancel the trade out. If your stop is hit, then your limit entry order is canceled.

Automated Traders, Be Sure to Read This! This Affects You the Most!

Now, here’s one more thing to consider. If you have automated trading programs like Metatrader’s Expert Advisors (EAs), chances are your automated program will NOT be coded to handle the new FIFO rule. Therefore, there will be tons of EAs that won’t work anymore come August 1st.

So if you have an automated program making trades, there’s a good chance you’ll either have to move your account (see below for some options). Or you’ll have to recode the program for the new FIFO rules. That will only cost you more money.

Personally, I’d just fill out your forms to transfer your account to another location…

Not Thrilled With These Rules? Pick Up And Move!

Now, if you want things to stay the way they were before, you do have some options.

There are firms that are regulated in multiple places. Some firms have “hubs” in each of these locations. All you have to do is fill out a form to transfer your account to that division of the company. This way, your Forex account will be ruled over by a different regulating body, and you can avoid all of these changes.

Don’t Like the Rules? Take Your Business Elsewhere…

For instance, say you moved your account to the U.K. The FSA (Financial Services Authority) rules over all British FX accounts. Surprisingly, the FSA actually has slightly better regulation than what they have in the U.S.

The reason? The FSA has been around longer, so they’re better equipped to regulate Forex firms. They also have segregated accounts, which force a firm to separate your account from the firm’s finances so it protects you even further. So there are added bonuses to moving your account to the U.K.

Australia is another place you could take their account and avoid these NFA rules. It’s up to you where you domicile your account. Just because you’re a U.S. citizen, doesn’t mean you have to have a U.S.-based account.

So check with your firm to see if they have a “hub” in the U.K. or Australia. If so, you may want to move your account over there and “vote with your feet” on what you think about the latest U.S. regulatory decisions.

If you’re prepared to deal with these changes, then keep your account right where it is. But just ask your Forex firm how they’re handling the changes so you can get used to the new changes as soon as possible.

Be sure to ask how orders will need to be placed. Some firms even have free videos on how you can do these new orders. Ask what information they can offer you.

Where to Go for More Information on NFA’s New Rules

If you’d like to see the official rule straight from the NFA’s site, you can read about them here.

If you’d like to see a good Q&A on the topic, then check out my friends at Dailyfx.com. They’ve put together a good web page here on all of the latest changes here.

Remember, these new rules aren’t the end of the world. Most Forex firms are already making preparations for them. The important thing is to know they’re coming.

So you have 10 days to prepare. Make sure to call your FX firm’s customer service line and ask what they can offer you.

Happy Trading!
Sean Hyman, aka Professor FX

P.S. In case you’re wondering, these new rules were supposed to go into effect by July 12, however the NFA has extended the deadline to August 1st to give Forex firms more time to prepare their clients. To learn more about how to make the most of your Forex account, click here.