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Every country has the right to create its own laws to control how financial markets are run within its borders. In the US, there are 2 institutions responsible for regulating the Forex market, the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). The Securities Exchange Commission (SEC) does not have authority over the Forex market because currency pairs are not considered a security.
The laws enforced by the CFTC and NFA apply to the Forex brokers based in the US and any other Forex broker who intends to sign up US residents as clients. Every Forex broker operating in the US is supposed to register with the CFTC and acquire a license from the NFA. (See the: Best US Forex brokers)
Laws governing Forex trading in the US
In the US, the main body of rules governing Forex trading is embodied in the Dodd-Frank Act which was signed into effect in 2010 by President Obama. It was a reform on precious financial regulation that allowed carte blanche to financial institutions and contributed to the 2007-2008 financial crisis.
The new laws had more restrictions on all financial markets, including the Forex market which experienced reforms.
Limits to Forex trading in the US
There are currently fewer Forex brokers operating in the US compared to other areas in the world, and this is because of the regulations by the NFA that seem to limit them. These regulations have put off both the Forex brokers and the retail traders, and they limit aspects like:
Leverage
According to the laws governing the retail Forex market, leverage was capped at 50:1 when trading major currency pairs and 20:1 when trading exotic pairs. Major currency pairs are those that include major currencies like the US dollar while exotic currencies represent smaller economies like the Turkish lira. (Learn: How to create a trading strategy)
The purpose of the leverage cap was to prevent people from losing too much of their investment when working with leverage without proper understanding. Forex brokers offer very high leverage that can reach levels like 1000:1, and this can seem like a very good deal to most traders. What people don’t realize is that leverage can also work against you, and the losses can exceed the investment. Amateur traders don’t realize this and they find themselves suffering from enormous losses. They need to learn more about leverage before using such high levels. (Find out: How to protect yourself from margin calls)
Since the NFA cannot dictate how much leverage each trader chooses, the forex market is decentralized after all, they instead sought to impose limits on the Forex brokers. Other financial regulators, such as MiFID II by the Financial Conduct Authority (FCA) are also imposing limits on leverage to the FCA-regulated forex brokers list, but traders can request higher leverage when they prove they have adequate understanding.
Hedging
Hedging in the markets is a crucial trading strategy to help reduce the number of losses you can suffer from a trade. Take, for example, if you had gone long on the EUR/USD, then the FED decided to raise interest rates, your trade would start running a loss.
One option would be to close the trade and open another one in the opposite direction, but you can also just open a long position with the same pair without closing the previous one. The latter strategy is referred to as hedging, and it ensures you gain even though another trade is running a loss, such that your ultimate losses are much less. If your trade is in the black, you can also increase profits by opening similar profits in the same direction.
However, the CFTC restricts hedging, so that traders cannot open two trades on the same currency pair simultaneously. With hedging, traders would keep holding onto losing trades for a very long time while opening simultaneous positions, which would leave the broker’s funds tied up in negative positions and impact the returns. Instead, the application of a First-in-First-out (FIFO) model by forex regulators ensures that traders do not impose an unnecessary load on the brokers.
It may seem like a restrictive policy for the trader, but ultimately it is a measure to protect the traders from unnecessary risk.
Taxes
Most forex broker companies will not require that you pay taxes, but Forex regulations in the US require US residents to file tax returns. This means that you should expect to get taxed when dealing with US-based Forex brokers. 60% of profits are counted as capital gains and are taxed at 15%, while the remaining 40% will depend on your income bracket. Considering that many other brokers don’t impose taxes, this law is often looked at as a limitation.
Listen as some experts talk about regulations in the US:
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