New anti-hedging rule

Hi Everyone,

In case you weren't informed, the NFA (National Futures Association) and CFTC (Commodities Futures Trading Commission) have introduced a new anti-hedging rule that will apply to all U.S. Forex brokers on 15th May 2009.

Basically, this anti-hedging rule will prevent traders from holding both a long and short position at the same time.

I've received quite a handful of emails from my members asking about this new rule, so here's my take on it:

Most retail traders (especially beginners) should NOT be using any form of "hedging" in the first place. In my experience, here's how new traders "hedge":

"John Doe opens a long position because he thinks the price is going up. Unfortunately, the price begins to fall past his entry point and he's now facing an unrealized losing position.

If John closes the position right away, he will confirm the loss. However, he now "realizes" that he had entered the trade a little too early, but is convinced the market will move back up soon.

To "cover" for any further drops in price, John then enters into a new short position to "protect" himself from any further loss, while praying for prices to go back up again."

This is basically what many retail traders consider a "hedge".

Now, I won't beat around the bush and try to be politically correct, so pardon me if you get offended - but this is a TERRIBLE way to be trading. If this is how you're trading, you've got to stop right now.

This type of "hedging" is actually based on "hope" and "desperation". John refused to admit he was wrong, and in his desperation to escape from confirming the loss, he dug himself into a deeper hole by opening the short position...

You see, there is only party that benefits from all of this... is the broker. Brokers rely on such "loss avoidance" behavior from traders to earn a little extra from the spread of the opening of the hedging position. And by opening the hedging position, John has in fact just delayed the inevitable loss, while completely eliminating any chance of making a profit (you cannot make a profit once you are hedged).

This being said, the new "no hedging" rule is actually a good thing for most retail traders. So Hurray!

BUT, this IS a downside to it...

Some traders hold both long-term and short-term trade positions at the same time - for example, the long term trend of a currency pair may be up, while the short-term trend is down. The new rule prevents traders from holding a (long-term) 'buy' position and (short-term) 'sell' position at the same time.

You can get around this by having two separate trading accounts - one for trading the long term, and the other for the short term. But I would only recommend this if you are an experienced trader.

Final Comments

I'm actually glad to see that the NFA and CFTC are taking steps to protect ill-informed traders from losing money unnecessarily...

Remember: in Forex trading, knowledge is the real currency.

Your friend,
Guru


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