New Forex Rules: What Traders Need to Know

10/20/2010 12:01 am EST

Focus: FOREX

Sam Evans

Instructor, Online Trading Academy

It is the job of every serious-minded forex trader out there to keep abreast of the latest news and events, which could potentially have an effect on their day-to-day trading activities. This month is a big month for the world of forex trading in that we will be seeing brand new legislation enforced which will no doubt ripple across the activities of all forex traders participating or looking to participate in the markets over the course of the future. This ruling has been met with praise by some and scorn from others, yet needless to say, it is here to stay and we should all be aware of its appearance moving forward. The ruling I am talking about is the introduction of the latest Commodity Futures Trading Commission (CFTC) compliance rule, which will substantially reduce the amount of leverage available to retail forex traders.

The ruling came into effect on Monday (October 18, 2010), and in simple terms, dictates that all retail forex traders will be required to maintain a minimum 2% initial and maintenance margin requirement for the major currencies, and 5% for all other currencies. As with most forms of legislation, these margin minimums are subject to change. The new regulation is intended to protect retail forex investors in the US by preventing excessive use of leverage, a typically common reason for many account blowouts and horror stories. Up until this ruling, forex traders have been used to working with a 1% margin requirement, and when considering the size of a $100,000 standard lot, this equates to a leverage ratio of around 100:1. Come October 18th, we will all have to get used to working with 50:1 leverage on the major currencies. According to the majority of broker dealers I have looked at, the "major" currencies will include the popular pairings of the following: Euro, British pound, Swiss franc, Canadian dollar, Australian dollar, New Zealand dollar, Japanese yen, and of course, the US dollar. For example, if you were looking to trade any of the currencies against the US dollar, you would now be looking to get 50:1 leverage on these trades, be it via standard, mini, or micro lot sizing of $100,000, $10,000, and $1,000 positions, respectively.

In the case of the cross pairs, which we would describe as any forex pairing that does not include the US dollar, traders are now required to hold a 5% margin guarantee, giving them 20:1 leverage ratio. While this is much greater than the majors, considering the potential volatility that the likes of GBP/JPY, AUD/CHF and EUR/CHF can show, the CFTC believes that this is a far more responsible ground for traders to stand upon and hopes that these rules will help to protect trading accounts across the board. Let's take a look at some examples in monetary terms of how this new legislation will come into play when taking a forex position on one of the majors, like EUR/USD:

Pre–October 18, 2010

Imagine we were working with a $10,000 trading account. The actual purchasing power would be in the sum of $1,000,000, which equates to available leverage of 100:1

  1. To take a trade with one standard $100,000 lot, the margin would be set at around $1,000 to take the physical position (depending on broker)

  2. To take the trade with one mini $10,000 lot, the margin would be set to around $100 to take the physical position (depending on broker)

Post-October 18, 2010

  1. Imagine we were working with a $10,000 trading account. The actual purchasing power would be in the sum of $500,000, which equates to available leverage of 50:1

  2. To take a trade with one standard $100,000 lot, the margin would be set at around $2,000 to take the physical position (depending on broker)

  3. To take the trade with one mini $10,000 lot, the margin would be set at around $200 to take the physical position (depending on broker)

NEXT: Will the New Regulations Negatively Impact Trading?

|pagebreak|

Now to some traders, this ruling has caused quite a stir, with an abundance of complaints against the CFTC for attempting to "babysit" forex traders and taking away a privilege which they have been enjoying and making use of for many years beforehand. On the other side of the fence, we have parties showing considerable support for these new, reduced-leverage measures, praising the CFTC in its efforts to protect the hard-earned capital of traders in the markets and its attempts to establish a better name for currency trading across the board.

Where do I sit on the matter? Well, to be honest, I have no complaints at all. You see, there was talk of this enforcement way back in January of this year, and unlike the resulting 2% and 5% official ruling which has been introduced, there was originally talk of adopting a far more conservative guideline of as great as 10% for majors and 20% for cross pairs, which would have squeezed leverage ratios down to as little as 10:1 and 5:1, respectively. So the fact that we have ended up with the numbers in place now is great news to me. Yes, I do believe that the originally proposed margins would have been a dramatic change to the forex trading environment, but let's face it: 100:1 down to 50:1 is really not much to get frustrated about and could help many reckless traders out there in extending the longevity of their trading capital during the tougher periods of market activity.

Aside from the fact that the reduced margins are a positive step towards containing oversized positions in the market, we should also remember that if one is truly trading responsibly in the forex markets, following a detailed plan with strict money management rules, this reduction in leverage should pretty much have no effect on the consistently profitable trader at all. As you well know from my previous articles, I like to only risk around 1% of my account capital on any particular trade, and so the percentage of my account which is used as margin is always minuscule in relation to the capital I actually have available to use at any given time. It is only when a trader is trading with too large a position size that they get margin calls, and if this is a common practice in their trading activities, then I very much doubt they will be around to trade for much longer anyway. Leverage of 100:1 or 50:1 makes no difference to my trading plan, as I never use all of my available buying power at any time. Just because I can does not mean I will, and my first priority in my trading rules is to manage my risk, then worry about the profits. Leverage is a powerful tool when used in disciplined hands, and a dangerous one in reckless hands. Just remember, it is not the market that takes money from the trader. It is the trader who gives their money to the market by not sticking to the rules of disciplined risk management at all times.

Still bothered about the reduced leverage? No worries then, as this ruling only goes into effect across accounts held in the United States of America...for now. If you do still want to use greater leverage, then you can always open a forex trading account with a broker outside of the US, but I see little point. Unless, that is, you are looking to load up the boat a little more from time to time, and we all know that the trader with that mindset has their focus on one thing only. Don't say I didn't warn you. I hope this helped.

By Sam Evans, instructor, Online Trading Academy

Related Articles on FOREX

Keyword Image
The Fabulous Shrinking Renminbi
09/27/2017 1:13 pm EST

As of August 2015, renminbi (RMB) in payments globally accounted for 2.8 percent of the total, the f...