Trading forex in the United States: Laws & Limits
Just because the Forex market is decentralised does not mean it’s the wild west, and there are laws that govern the industry. In charge of enforcing these laws are the financial regulators, and every country has its own regulator. In the US, 2 bodies ensure the Forex market remains fair – the CFTC and the NFA.
Forex brokers are supposed to be registered with the CFTC and acquire a license from the NFA before operating in the US. Each Forex regulator operates within their country, and they are free to create and amend laws governing Forex trading as they see fit, even if their laws are different from other regulators’.
In the US, regulations on Forex trading are quite different from those enforced in other regions of the world. Forex brokers often complain that the laws are prohibiting, which explains why there aren’t many brokers licensed by the NFA. Nevertheless, there are still a couple of brokers that do have all the required licenses in the US and also often accept all traders who have at least the ITIN number.
Some of the Forex regulations in the US that are different from those in other countries are those surrounding:
It was the concept of leverage that made the retail Forex market as he as it is today because it enables traders with lesser capital to participate at the same level as those with more capital. In principle, a broker can provide in a lot of parts of the world as much leverage as they want, which is why there are brokers with leverage as high as 1000:1.
However, the regulators can dictate how much leverage they consider appropriate, and this is what the CFTC did. In 2010, the Dodd-Frank Act was created to regulate financial markets. Among its new regulations was a cap to leverage at 50:1 on major currency pairs and 20:1 on exotic pairs. The idea behind the cap was to reduce the risk taken by investors in the markets who did not fully understand the downside of leverage. Similar leverage reductions can be also seen by regulatory bodies in the EU or Australia.
Leverage is a double-edged sword that could increase a trader’s profits, but it also increases the losses. By capping leverage, the US regulators wanted to reduce the risk involved in trading. Obviously, this makes Forex trading in the US by many traders more difficult if they don’t have the necessary capital, but that’s just the way it is.
When you’re holding a losing trade, a trader has 3 options – close the trade, keep holding on to the order until the trend turns around, or place an order in the opposite direction. The latter is referred to as hedging, and it is an effective strategy used to reduce losses when trading. For example, you can place a sell order on a currency pair if the long order already active is in the red.
Despite being effective, US Forex regulations don’t allow hedging, instead of making use of a First-in-First-out model. This means that if you attempt to place another order on the same currency pair, the previous order would be closed first regardless of the profits or losses. Again, this trading model restricts a lot of flexibility from the trader, but that’s just the way it is in the US.
When dealing with money, the clear worry has got to do with the security of the deposited funds. Every trader needs to feel that their money is safe, so the US Forex regulators set out to prevent any cases of losses. Some measures that were taken by the NFA to ensure fund security include:
A check for broker's license
As an online business, it is possible for Forex brokers to claim they are regulated by a regulatory body even when they aren’t. The NFA thus offers a regulatory status check feature on their website where you can input a broker’s NFA ID and confirm if they are really licensed.
Storage of client funds
A Forex broker is not supposed to keep a client’s funds – this role belongs to banks and brokers should not deposit client funds into their own accounts. The fear of this is that a broker can choose to abscond with the funds, and t would be safer to keep them in a separate account. The NFA requires that brokers keep funds at a recognised financial institution based in the US.
There are clearly very different laws governing Forex trading in the US, and as mentioned before, the Forex brokers do not particularly favour them. Nevertheless, all these new laws have been put in place just so that the traders are more secure, even though it limits them. Whether these laws are actually punitive depends on a person’s perspective.
For me, it always seems like the same strategy to teach abstinence in schools instead of birth control. And as we all know by now, this strategy does not help with teenage pregnancy. It’s always better to provide people with all options and let them decide rather than limiting their reach.