CFTC Proposing 10:1 Leverage Requirement - Here is what you can do

Did the recent restrictions on hedging, 100:1 leverage and FIFO affect you as a forex trader?  Probably not.  I saw them as a minor inconvenience and as ridiculous as they were, not enough to limit my trading.  However, the CFTC in the United States has proposed a new set of restrictions on the US Forex market and this is how it can affect you as a retail forex trader.

Just the facts

First of all, here is the official CFTC press release and the actual proposal:

• http://www.cftc.gov/newsroom/generalpressreleases/2010/pr5772-10.html
• http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/forexrulesproposal.pdf

Whew, what did you think?  If you don’t want to read 193 pages, here is what I took away from it.

Financial Stability

Under this proposal, there would be a $20 million net capital requirement, plus 5% of any liability to retail forex customers above $10 million.  This is to ensure that dealers have a reasonable amount of financial stability to protect client funds.

Remember what happened to Refco FX?  Of course this requirement would not completely eliminate that risk, but it would at least provide some guidelines.  The good thing is that most of the major dealers in the US already meet this requirement.  Click here to see where your dealer stands.  If your current dealer is under capitalized, you should probably move your money to a bigger company.

This is a great idea.  Sure it will kill of some of the smaller dealers, but I believe that brokers should be well capitalized.

Registration and regulation

This new proposal would require all brokers and money managers to register with the CFTC.  Dealers would be required to register as Futures Commission Merchants (FCMs) or Retail Foreign Exchange Dealers (RFEDs).  Money managers would be required to register as a Commodity Trading Advisor (CTA) or a Commodity Pool Operator (CPO).

In addition, the people who promote these services, Introducing Brokers (IB), would also be required to register.   Furthermore, IBs would have to be guaranteed by their respective FCM or RFED.  This is to impose some self regulation on the part of the dealers.

All of these registered entities would have to adhere to record keeping and disclosure requirements.  This will prevent “creative accounting” and unscrupulous reporting and promotion.

I think that requiring registration and disclosure is a great idea.  There have been a lot of scams related to forex and theses regulations will go a long way to preventing this in the future.   I’m not sure the brokers will go for guaranteeing their IBs because then it makes more sense to just have an in-house sales team, but that is for the dealers to dispute.

Margin requirement for traders

This is where I have to draw the line.  The proposal wants to limit the margin requirements on forex transactions to 10:1.  I do not want the government limiting my ability to make a living by imposing such restrictions.  The fact is that in any trading arena, there are only a small number of people who become professionals.  Why is this?  Because trading is a tough business and in order to be successful, you have to understand the risks.

People will still blow out their accounts even if there was no margin!  Look at the stock market, most accounts trade at 1:1 or 2:1 at most and people still manage to lose all their money.  Reducing the leverage will not reduce the risk.

Most beginning traders look at the maximum number of lots that can be traded with their money and the CFTC wants to reduce this by making the margin requirement higher so fewer lots can be traded.  If someone is going to risk their entire capital on every trade, it is just a matter of time before they lose it all, regardless of the margin required.

What traders should really be looking at is how much they can afford to lose.  Let’s say a trader with good money management has a risk tolerance on any trade of 2% of total equity.  Therefore, in a $1,000 micro account (trading 1,000 unit lots) the most they could afford to lose on one trade is $20.  At $0.10/pip, that is 200 pips.  That is the same if the margin requirement is 400:1 or 10:1, correct?  The only difference is the amount that would have to be put aside for margin.

What it comes down to

It is my right to be able to choose the amount of leverage I use depending on my strategy and I strongly oppose this new margin requirement.  I wholeheartedly believe that forex is the best market for individual traders because of it’s liquidity, significantly reduced slippage, low transaction cost and ability to start with a small amount of capital and make it grow.

If they do impose these restrictions, then you can do a few things:

• Move your account to a overseas broker.  I have already opened accounts with FXCM UK and if these requirements do go into place, I will move all my accounts there.  This will open up another can of worms however because foreign brokers may be even less regulated than the current US brokers, leaving traders open to even more risk.  I have reasonable faith in the British government, but any country will always look to protect their own people first and as US citizens, we will not have much of a say if they ever decide to change their laws.  In addition, this will take income and jobs away from US brokers and employees.
• Put more money in your account…10 times more.
• Adapt your trading strategy or create a new one (the least favorable, especially if you already have something that works).

How you can take action

Should you feel strongly about this proposal, there is still time for you to help determine the outcome of these proposed regulations. You can make an impact by sending comments directly to the CFTC at: secretary@cftc.gov.

Please include ‘Regulation of Retail Forex’ in the subject line of your message.

You can also submit your comments by any of the following methods:

• Fax: (202) 418-5521
• Mail: David Stawick, Secretary
  Commodity Futures Trading Commission
  1155 21st Street, N.W.,
  Washington, DC 20581
• Courier: Use the same as mail above.

Also contact your local US Representative and voice your opinion.

Conclusion

If you feel as strongly as I do about these proposals, I urge you to take action and be heard.  Some people may say, “I will just move my account to a foreign broker.”  This is a possibility, but I think we need to fight for our rights at home in the US.

If they limit our ability to trade like this now, what will they do in the future?  In addition, if these rules go into place in the US, other countries may use that as a precedence to invoke their own similar laws.   Like I mentioned before, we will not have as much of a say with regard with laws in other countries, so we should fight is as much as we can here, while we still have the opportunity.