BarroMetrics Views: NFA Rule 2-43 (b): “first-in, first-out” (FIFO)
The NFA regulation continues to raise passions: on one side you have comments like:
“There are quite a few rumors and even some scare tactics going on about the recent changes to the NFA rules and some are even trying to make it sound so bad that if you don’t move your account overseas, you’re pretty much buggered as an individual trader.
Don’t listen to the B.S.!
The NFA and CFTC are there for a purpose and that is to look out for you - by keeping the brokers in line!”
On the other hand, you’ll see comments like:
“Traders who trade via forex brokers regulated by NFA will no longer be able to place stop-loss or limit orders. The ability to modify or close trades from “Open Positions” window is also no longer available”.
In this blog, I look to present the facts and my opinion on the regulation. For the record I do not trade FX with US based FX brokers.
First off:
FACT: The rule came into effect on July 31 2009. I have been unable to discover if there have been any extensions granted.
Secondly:
FACT: The intention behind the rule was to stop the practice of hedging. Hedging means traders hold a long and short position open for the same instrument and the same volume at the same time.
OPINION: Now think about this for a moment. If I hold 3 contracts of Dec Gold long at US$330 and 3 contracts of Gold short at US$300, I have NO position and I have a loss of (US$30.00) per contract. This is the reality.
But the practice is theoretically designed to reduce an initial loss. Both legs are kept open (my view is this is done because the trader seeks to deny the loss) with the intention of lifting a leg (usually one that is in profit, e.g, in this case, let’s say we lift at US$360) and keeping ‘open’ the other leg.
In the example above, we would now be short at US$300. We’d lift that leg at any price that allows us to have than US$30. In my experience, a trader looks to break-even or to make a small profit on this leg.
The advocates of hedging are passionate in their defense of the practice. Others believe that the practice is a blight on the trading world and the only ones to profit are brokers.
That’s the theory. What is the reality?
In 30 years of trading and 20 years of teaching, I have never seen this practice work.
Putting aside the nonsense of pretending that a long + short is NOT a closed position - the moment you lift the profitable leg, you are immediately exposed to losses that can increase. Here is the insidious nature of this practice: because you view the ‘lifting of a leg’ not as a fresh position (which is what is happening) but merely ‘lifting a hedge’ most of us fail to plan for an initial exit strategy(i.e. have a stop loss). At the back of our minds, we can always re-hedge. The net effect is that we have an expanding open loss.
The only ones who profit are the brokers because each hedge inevitably leads to more commission. Consider this: If a trader is silly enough to blow his whole account on one trade (no stop loss), via ‘hedging’, the broker picks up at least one more set of fees and usually a great many more sets.
Now I don’t blame the broker, he is there to provide a service; a service that is wanted by a great many traders. And until the new regulation, the practice was legal. I liken this to those selling quick rich trading systems (false promises) that could not possibly do what they promise over a large sample size. The systems sell because traders buy them.
So, in my view, if the NFA charter is to protect the trader, then NFA was doing right by seeking to abolish the practice of hedging.
More tomorrow.
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