In 2009, the NFA adopted a FIFO rule, which then affects the whole forex trading industry in the US. So, what is the FIFO rule and how does it work?

Since the early 1990s, the world of trading has shifted into a new and modern era that we know today. Traditionally, trading was usually carried out by a group of well-trained and educated people. But since the invention of home computers and the internet, practically anyone can access various financial markets from the comfort of their homes. This has obviously brought fresh changes to the whole industry and democratized it so that people from different backgrounds, genders, ages, and levels of expertise can participate.

The FIFO rule in forex trading

As more people join the market, the urgency to regulate the market also increases. So after the 2008 economic crisis, the US government decided to adopt several new trading rules in order to regulate the market and the brokers to protect US traders. One of them is the FIFO trading rule.

 

What is the FIFO Rule?

First of all, FIFO stands for "First In, First Out". It is a policy that serves as the base of Rule 2-43b, which was issued by the National Futures Association (NFA) and went into effect in May 2009. The FIFO rule essentially requires traders to close the first trade before opening another new trade of the same pair and size.  It applies to all US-based brokers that are regulated by the NFA.

 

How does the FIFO Rule Work in Forex Trading?

The easiest way to understand how the FIFO rule works in forex trading is by looking at an example. Let's say you want to trade GBP/USD and use a scaling strategy, so you open three long positions on GBP/USD at three different times and entry levels.

  • Position 1: Opened a 100,000 units long position in GBP/USD at 1.6000 on February 1st.
  • Position 2: Opened a 100,000 units long position in GBP/USD at 1.6100 on February 2nd.
  • Position 3: Opened a 100,000 units long position in GBP/USD at 1.6200 on February 3rd.
  • Total Position: 300,000 units long in GBP/USD.

In that case, if at some point the GBP/USD moves back to 1.6100 on February 4th and you decided to sell off your 100,000 units of your overall position, then according to the FIFO rule, you need to close the 100,000 units that you bought at 1.6000 in your first order. The broker won't allow you if you wish to close the 100,000 units that you opened at 1.6100 in your second position.

See also: List of Brokers with the Lowest Spreads on GBP/USD

The same logic also applies if you have several positions of the same currency but with various position sizes. Take a look at the example below.

  • Position 1: Opened a 100,000 units long position in GBP/USD at 1.6000 on February 1st.
  • Position 2: Opened a 25,000 units long position in GBP/USD at 1.6100 on February 2nd.
  • Position 3: Opened a 100,000 units long position in GBP/USD at 1.6200 on February 3rd.
  • Position 4: Opened a 75,000 units long position in GBP/USD at 1.6300 on February 4th.
  • Total Position: 300,000 units long in GBP/USD.

Under the FIFO rule, if you wish to close 25,000 units with a market order, then it will be taken from Position 1 since it is the first or oldest position you've opened. Similarly, if you want to close 150,000 units with a market order, the number will be pulled from the oldest trade first, so you'll end up with 75,000 units in Position 3 and 75,000 units in Position 4.

Keep in mind that in such a scenario, you're still allowed to manually close Position 2 and 4 because you don't have other positions of the exact same size. But if you want to manually close Position 3, the platform will tell you that you need to close Position 1 first.

The FIFO rule also applies to hedging since you need to close the first position before opening a new position with the same trading size and currency pair. The broker simply won't allow you to open two or more opposite positions on the same currency pair simultaneously. So if you have an open long position in GBP/USD, then you won't be able to open a new short position on the same pair and size unless you have closed the long position first.

 

How to Avoid FIFO in the US

It's important to note that FIFO was essentially designed to protect traders from scams and serious losses. Even so, many traders who trade with US-based brokers still wish to get around the FIFO rule and practice hedging. This is actually possible to do, but you need to do a little advanced planning. Even if you're an expert, you need to have a well-planned strategy that you've already tested before trying out this tactic.

Hedging is basically opening two trades in the opposite direction so the risks from each position can be offset. Now since the FIFO rule doesn't allow you to hedge in the same account, the easiest way to get around the rule is by opening two different accounts: one for long trades and one for short trades.

So, if the balance in one account drops and the other starts going up in profit, you just have to transfer money between the accounts to balance them out. However, make sure that your broker allows transfer between accounts.

Apart from that, you can also avoid being subject to the FIFO rule by using different sized lots or different currency pairs with negative correlation. Remember that the FIFO rule only applies if a previously entered position has the same trade size in the same currency pair. It would be a big help if your broker allows you to open small lots, such as micro or nano lots.

With that being said, you just need to plan your order entries so that you can enter and close your positions at the best prices. To make it easier, you'd want to break down your positions into unit sizes that you wish to incrementally exit.

If at one point you accidentally place a buy order after a series of sell orders in the same account, don't worry because the amount will be subtracted from the oldest open position. So let's say you accidentally bought 100 units after selling 1,000 units and 500 units respectively. Then the 100 units will be taken from the oldest position, leaving you with 900 units in the first position and 500 units in the second position.

However, it's worth mentioning that the tricks may not work in all brokers because some brokers don't allow nano lots and blends trades together. Even if they did allow nano lots, the blending system won't make the strategy work.

 

Final Words

Apart from prohibiting traders to open multiple positions of the same currency pair that could offset each other, the FIFO rule also bans price adjustments to execute client orders, unless it is used to resolve a complaint that is in the client's favor. Lastly, the rule limits changes to some straight-through processing transactions. This means that every change made should be reviewed, approved, and documented by the NFA first.

Ultimately, the FIFO rule is a part of the government's attempt to regulate the forex market in order to ensure fair and ethical business between traders and trading firms. We need to understand that regulators are just trying to build a safer trading environment and make online trading less one-sided by protecting retail traders.

If you are a US-based trader and know how to make profits out of hedging strategy, there are some legal ways that you can use to get around the FIFO rule. What you need to remember is that these methods are considered pretty advanced and might not work in every broker.

For these reasons, make sure to master the basics first, prepare a good trading strategy, and don't forget to test them in a demo account before investing real money in it.