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Forex traders, in particular those in the USA, may have seen considerable debate over recent weeks regarding the new First-In-First-Out (FIFO) rule being implemented on August 2, 2009. Personally, I’ve kept out of this debate as it doesn’t apply in my country, it doesn’t apply to my style of trading and, to be honest, it’s really blown out of proportions. However the last week I’ve become quite annoyed at the misinformation, half-truths and in some cases outright lies, which have been spread by some in the industry. In recent emails there have even been claims that this ruling threatens the potential profitability of many forex traders, effectively ending their career, due to the inability to now use risk management tools such as stop loss orders and the prohibition of the use of orders to take profit at predetermined price targets. Absolute rubbish! Yes, for retail traders operating through a National Futures Association (NFA) registered broker, there will likely be changes to the way you manage your positions. And those who trade multiple strategies over multiple timeframes, and are therefore potentially long and short at the same time in the same currency, will need to consider the use of separate accounts. But it’s not the end of the world. So, here’s what FIFO involves. The new rule which is causing all the debate is NFA Compliance Rule 2-43 (b), which states in the first sentence: · Forex Dealer Members may not carry offsetting positions in a customer account but must offset them on a first-in, first-out basis. A copy of the rule is available athttp://www.nfa.futures.org/news/PDF/CFTC/CR2_43_ForexPriceAdj_112408.pdf What does this mean? In the past, when operating with multiple entries in one currency pair, in one direction, you were able to attach stop loss and/or profit target orders to each of the individual entry tickets. This option is no longer available. However, you can still place a stop order at the same price as your previous stop-loss order. And you can still place a limit order at the same price as your previous profit target. And if your broker is worth dealing with then they should offer these orders one-cancels-other (OCO), such that execution of either your stop or target order will cancel the other. The difference is that these orders do not apply to one particular entry order, but instead apply to the aggregate position on a first-in, first-out basis. It’s probably best demonstrated through an example. In the past you may have operated as follows, as price on GBP/USD rallied from 1.6500 to 1.6600: · Price level 1.6500 o You’re bullish on GBP/USD so you enter the following trade (let’s call it trade 1): o BUY 50,000 GBP/USD at 1.6500, stop loss 1.6450, target 1.6600 · Price level 1.6520 o You wish to add to the position so you enter the following trade (let’s call it trade 2): o BUY 20,000 GBP/USD at 1.6520, stop loss 1.6490, target 1.6580 o You currently have two positions open, trade 1 and trade 2, with position sizes of 50,000 and 20,000 respectively. · Price level 1.6530 o You wish to add further size so enter the following order (let’s call it trade 3): o BUY 10,000 GBP/USD at 1.6530, stop loss 1.6510, target 1.6550 o You now have three positions open, trade 1, trade 2 and trade 3, with position sizes of 50,000, 20,000 and 10,000 respectively.
· Price level 1.6550 o The target has been reached for trade 3. o Trade 3 is automatically closed out for a profit of 20 pips. Its stop loss order is removed from the system. o Trade 1 and 2 are still live, with position sizes of 50,000 and 20,000 respectively.
· Price level 1.6580 o The target for trade 2 has been reached. o Trade 2 is automatically closed for a profit of 60 pips. Its stop loss order is removed from the system. o Trade 1 remains, with its position size of 50,000.
· Price level 1.6600 o The target for trade 1 has been reached. o Trade 1 is automatically closed for a profit of 100 pips. Its stop loss order is removed from the system. o No open trades remain. So, trades were entered in the order 1, 2 and then 3. And they were closed out in the order 3, 2 and then 1, as the exit prices were reached. Here’s how it works now… · Price level 1.6500 o You’re bullish on GBP/USD, so you enter the following trade: o BUY 50,000 GBP/USD at 1.6500 o On execution you wish to protect your position so you enter the following pending orders: o SELL 50,000 GBP/USD at STOP 1.6450, SELL 50,000 GBP/USD at LIMIT 1.6600, one cancels other (OCO)
· Price level 1.6520 o You wish to add to the position so you enter the following trade: o BUY 20,000 GBP/USD at 1.6520 o You place the following pending orders to protect your position: o SELL 20,000 GBP/USD at STOP 1.6490, SELL 20,000 GBP/USD at LIMIT 1.6580, one cancels other (OCO) o You currently have two positions open, position 1 and position 2, with sizes of 50,000 and 20,000 respectively · Price level 1.6530 o You wish to add to the position so you enter the following trade: o BUY 10,000 GBP/USD at 1.6530 o You place the following pending orders to protect your position: o SELL 10,000 GBP/USD at STOP 1.6510, SELL 10,000 GBP/USD at LIMIT 1.6550, one cancels other (OCO) o You now have three positions open, positions 1, 2 and 3, with sizes of 50,000, 20,000 and 10,000 respectively.
· Price level 1.6550 o The sell limit order (the target order placed at the time of position 3 entry) is executed, cancelling the attached stop order. o 10,000 GBP/USD are sold. This comes from the first position established, hence the name First-In-First-Out. o Position 1 now remains with a size of 40,000 (initial 50,000 minus 10,000) o Position 2 and 3 remain intact, with position sizes 20,000 and 10,000.
· Price level 1.6580 o The sell limit order (the target order placed at the time of position 2 entry) is executed, cancelling the attached stop order. o 20,000 GBP/USD are sold. This again comes from the first position established. o Position 1 now remains with a size of 20,000 (initial 50,000 minus 10,000, minus 20,000) o Position 2 and 3 remain intact, with position sizes 20,000 and 10,000
· Price level 1.6600 o The sell limit order (the target order placed at the time of position 1 entry) is executed, cancelling the attached stop order. o 50,000 GBP/USD are sold as follows: § The remaining 20,000 in position 1 are closed. § The 20,000 from position 2 is closed. § The 10,000 from position 3 is closed. o No open positions remain. Or, you may find it easier to think of just one aggregate position, rather than three separate positions. Many brokers will provide a summary position, which just reports the total size long or short along with the average entry price. · Price level 1.6500 o LONG 50,000 GBP/USD · Price level 1.6520 o LONG a total of 70,000 GBP/USD. · Price level 1.6530 o LONG a total of 80,000 GBP/USD. · Price level 1.6550 o LONG a total of 70,000 GBP/USD.
· Price level 1.6580 o LONG 50,000 GBP/USD
· Price level 1.6600 o Flat. THE END RESULT IS NO DIFFERENT, IN TERMS OF PROFIT OR LOSS. It’s just a different way to manage the position. And there should be no loss of risk management functionality. The difference is that your stop and target orders are not attached to one particular entry. They’re just pending orders to execute a closing transaction (either scaling-out or all-out) at a particular price, with the open positions closing in a first-in, first-out order. Or if you prefer to look at it as one aggregate order, they just come off the whole average position. If you’re confused, just go through the exercise a couple of times. There is some mental gymnastics involved for those who may have not traded futures or any other FIFO instrument before. But once you’ve got it it’s easy enough. It’s not a bad change; it’s just a different way to operate. The amount of impact this has on you will obviously depend on both your strategy and also your broker. For those who enter their trades all-in with one transaction, and then exit all-out in a single transaction, there’s little change. For those who scale in and out, the impact will depend partly on how your broker has implemented the ruling change. Some of you may need to adjust the way you manage your orders, as per the discussion above, simply viewing the multiple positions as one aggregate position. It appears though that some brokers are addressing these changes entirely within their back-end. Traders will continue to operate much as before through their front-end platform, effectively trading virtual positions, which then equate to the real aggregate position hidden in the background. Either way – it’s not the end of the forex world as some are suggesting. Having said all this, please don’t misunderstand my position. I am never a fan of regulation that limits the choices available to consumers. If a trader wishes to operate through a broker who does not operate in accordance with the FIFO system, and the broker is happy to provide that service, then in my opinion its no-one else’s business. We’re all adults here and should have the right to make our own decisions. So, none of the above comment should be taken as supporting the ruling. What I do object to though is the lies, misinformation and scare tactics. If you operate with a US forex broker I expect they should have already contacted you to inform you of the changes that will be introduced this week, in particular how it will change the way you manage orders within their platform. If you haven’t received information or are unclear about how this will impact you, contact your broker and get the facts rather than rely on advice provided through the forums and snake-oil-salesmen emails. |
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