New Regulations Ban Hedging

US based forex brokers that offer the MetaTrader platform will have some work to do to comply with the latest regulations from the National Futures Association, which will be introduced on May 15th.  So will the developers and users of a lot of forex "robots".

New NFA compliance rule 2-43(b) (Offsetting transactions) will put an end to the practice of having both long and short positions open in the same currency pair at the same time, commonly referred to as "hedging".  This ability is relied on by some expert advisors, which will need to be rewritten before the deadline.  Many users also run more than one robot on one currency pair, and this will be impossible to do successfully after May 15th.

Using more than one forex trading system at a time is an effective way of gaining  some valuable diversification, so this could potentially be a major problem. Some brokers allow one individual to open numerous accounts, which could provide a solution.  However this will cause yet another problem – a need to put more total capital into all those new accounts, or at the very least to be prepared to frantically transfer cash on a regular basis from an account that is showing a healthy profit to one where the robot is experiencing a significant drawdown.

The stated aim of the NFA is to protect naive retail investors. In a letter to the Commodity Futures Trading Commission they say that:

NFA is concerned that customers employing this strategy do not understand either the lack of economic benefit or the financial costs involved….

One way it increases costs is by doubling the expense of entering and exiting the transactions…. Additionally the customer pays carrying charges that always exceed the funds that it receives…. Furthermore, if the bid-ask spread on the currency pair widens, as may happen when volatility increases or the Forex Dealer Member anticipates major market events, the customer's account equity may fall even faster.

The NFA's concerns may well be justified, but if you are aware of these issues and nonetheless currently employ hedging you are likely to find the new rules a major pain in the posterior.