Forex Trading in the United States
The worldwide forex market is extremely liquid, with an enormous daily trading volume. Furthermore, the market is open for trading 24 hours a day, five days a week, which allows you to set your own trading schedule. Therefore, because of its advantages and conveniences, the forex market has attracted a huge number of investors from all over the world.
However, forex trading in the U.S. is not the same as in other countries. Although the forex market is decentralized, traders in the U.S. have more restrictions than those in off-shore countries. The forex trading environment in the U.S. is heavily regulated, and brokers have to adhere to strict guidelines.
Understanding the United States Forex Trading Environment
The United States forex trading industry is very different from the rest of the world. Primarily, providing forex brokerage services in the country is not as simple as offering the same services in other countries.
In the U.S., a forex trading customer is defined by the law as any person or entity whose value of net worth is less than $10 million. In itself, the U.S. law is intended to safeguard the interests of small investors.
Regulation of the U.S. forex trading industry was tightened in response to the worldwide financial crisis of 2007-2010. In 2010, the Dodd-Frank Act was signed into law to patch up business activities on Wall Street and safeguard consumers from exploitation. However, its passage resulted in the downfall of several U.S. forex brokerage firms.
In 2006, there were about 50 brokerage firms offering forex trading services to customers in the country. However, following the sweeping Dodd-Frank legislation, that number has reduced significantly. The law also forbids forex brokers from other countries from recruiting U.S. customers.
Since the implementation of the Dodd-Frank Act, the U.S. market share in the forex industry has reduced considerably. In 2009, the country’s share of the worldwide retail forex trading volume was 6%. In 2016, that share had decreased by half to 3%.
The U.S. government has stipulated strict regulatory requirements that brokers (including introducing brokers) interested in offering services to customers must adhere to. Before allowing U.S. citizens, the brokers must be registered with the NFA (National Futures Association) and regulated by the CFTC (Commodity Futures Trading Commission).
The NFA and the CFTC define the regulatory framework that upholds transparency, honesty, and protection of different market participants. Together, the two agencies ensure the U.S. forex industry is as fraud-free and fair for all as possible.
The existence of much stricter rules in the U.S. has made the forex industry to thrive in places with more relaxed regulations around the world.
Role of the CFTC and NFA
Created in 1974, the CFTC is an independent U.S. government agency that is tasked with ensuring transparency and integrity in the financial markets by preventing risks such as fraudulent market activities, manipulation of market conditions, and financial malpractices.
Here is a screenshot of the CFTC website.
Since the market chaos of the 2007-2010 financial crisis, the agency has been introducing strict operating protocols that govern the working of brokers and other financial firms within its jurisdiction. Ultimately, CFTC aims to enhance the overall trust and confidence among traders concerning the safety of their funds and trading capital.
To eliminate fraudulent activities in the U.S. forex market industry, the CFTC continually updates its online scam list as well as the RED List (Registration Deficient List) with the latest deceptive incidents. If a broker is regulated by CFTC and is caught violating any regulations, the agency will take the necessary actions to protect investors, including enacting heavy fines and sanctions.
On the other hand, the NFA works under the CFTC to maintain the integrity of the U.S. financial markets. The NFA was established in 1982 self-regulatory organization. The CFTC requires forex brokers and many other forex firms to be registered with the NFA.
Here is a screenshot of the NFA website.
Instead of regulating brokers and other financial arms directly, the CFTC extends much of that responsibility to the NFA. The NFA is tasked with regulating the activities of any person or company intending to take part in the U.S. financial industry.
Both agencies collaborate with each other to supervise the actions of the member firms and ensure adherence to transparency and fraud-free conditions. They also take part in handling consumer dispute resolution issues.
Nonetheless, each forex trading broker operating in the U.S. should get a registration certificate from the CFTC, even though the NFA watches over the regulation of such firms. As such, the financial activities of a CFTC forex trading broker are appropriately regulated by the NFA. With the dual regulation, possibilities of financial malpractice and investor abuse are greatly reduced.
U.S. Forex Trading Regulations
a) Minimum capital requirements
The Dodd-Frank regulations, which are administered by the CFTC, have placed very high minimum capital requirements for forex brokers.
Any retail forex trading firm operating in the country must have a minimum capital of $20 million. And, they must have 5% of the amount if liabilities to traders is more than $10 million.
With this minimum capital rule, the CFTC intends that brokers should be capable of sustaining their customers’ positions without being declared bankrupt if the markets experiences unexpected volatility.
Comparatively, the minimum capital requirements in Cyprus, a home for many forex brokerage firms, varies from about $42,000 to about $1 million.
Cyprus has been attractive to most brokers since its European Union membership enable firms in that country to legally offer forex trading services to other countries within the Union while being under less-strict regulation than would be imposed by many other EU countries.
b) Leverage
Leverage is what makes forex trading sweet—although it can be a double-edged sword. In fact, the forex industry has largely grown because leverage allows traders with little capital to open trades with a larger amount of money. That’s why some brokers offer enticing leverage levels of up to 1000:1.
However, regulations in the U.S. limits leverage to 50:1 on most major currencies. 33:1 on a few others, and 20:1 on exotic pairs. This restriction was applied to lower the risk taken by investors who fail to understand the disadvantages of leverage properly.
It is true that if used wrongly, leverage can greatly amplify a trader’s losses. Through employing a restriction on leverage, the U.S. regulators intend to ensure traders practice proper risk management strategies and stay away from unnecessary losses. Apparently, this makes forex trading less lucrative to U.S. traders without sufficient capital.
c) Registration
The U.S. regulations make it obligatory for all financial institutions—such as forex brokers, introducing brokers, and fund managers—to be registered with the CFTC and regulated by the NFA before offering their services to clients in the country.
Both the CFTC and the NFA give every forex brokerage firm a unique registration number, which is publicly accessible. The CFTC has a comprehensive online database of fully certified brokers,. NFA BASIC allowss searching for all registered firms and individuals. Before investing funds with a broker, traders can search to confirm the company’s authenticity.
Furthermore, registered forex brokers are required to offer frequent audit reports and financial records to the NFA. The reports should demonstrate how a broker manages its finances as well as the customers’ money.
d) Hedging
If you are on a losing trade, you have three options—exit the trade, continue holding the trade until the market changes direction, or open another trade in the opposite direction.
The last strategy is called hedging, and it’s useful for lowering the effect of losses on a trade. For example, you can place a buy order on the EUR/USD if your sell order does not behave as expected.
Regardless of being useful, hedging is not allowed in the U.S. The country’s regulators believe that hedging works to the disadvantage of traders because it makes them pay double spread fees and incur increased trading costs.
In fact, brokers in the U.S. are required to enforce what is called First-in-First-out rule. The FIFO rule obliges brokers to exit traders’ running positions in a single currency pair based on the order in which the positions were placed.
For example, if a trader has two running positions on the EUR/USD, the first order should be exited first before exiting the second one. As such, when a trader tries to exit the second order, the first one will be exited automatically, irrespective of the losses or profits accrued. Again, this regulation makes trading forex in the U.S. less flexible and more difficult, but that’s the way the country operates.
e) Funds security
The security of funds is critical for every forex trader. As such, the U.S. regulators have established several measures to ensure traders do not lose their hard-earned money.
Chiefly, the CFTC has tasked the NFA to ensure that every regulated broker keeps its funds in a segregated account, which is different from the broker’s own operating accounts. This way, brokers cannot escape with the funds if the unfortunate happens.
The NFA directs that every broker should keep its funds with a recognized financial institution within the country. Also, the use of credit cards for funding forex trading accounts is not allowed, but debit cards are.
U.S. Forex Brokers
Despite the strict regulatory environment, some brokers have remained under U.S. regulation and are still accepting U.S. clients.
Conclusion
As illustrated in this article, forex trading in the U.S. is different from the rest of the world. While the existence of the strong regulations is healthy to ensure the forex industry stays reliable and transparent, the strict guidelines have prevented most forex brokers from establishing their offices in the country and have driven many former US brokers overseas .
Therefore, if you want to trade with a U.S. regulated broker, you should carefully consider if the benefits are suited for your specific condition.
Happy trading!