The Commodities Futures Trading Commission (CFTC) has raised the ire of thousands of small investors with new rules that would limit the amount of leverage allowed in the retail foreign exchange or forex market. This might have the practical effect of shutting out many smaller traders from trading foreign currency. (Learn more about forex in Common Questions About Currency Trading.)

The proposed rules by the CFTC would allow maximum leverage of 10:1 for retail investors in the forex market, compared to the current leverage limits of 400:1. A trader can currently put down $1,000 in capital and trade up to a notational amount of $400,000. If the rules go through as is, a trader can only control $10,000 in notational for every $1,000 in equity.

In Pictures: Top 10 Forex Trading Rules

This move by the CFTC was precipitated by the passage of the Food, Conservation, and Energy Act of 2008, which expanded and clarified the authority of the CFTC over retail off-exchange foreign currency transactions.

A Storm Of Protest
The proposed changes have unleashed an avalanche of comments and complaints from small traders and the firms that service them, most of which are in opposition. Those opposed to the proposed rules offer a range of arguments against these new rules.

  • The "Little Guy" Argument
    Many of the commentators frame their arguments around a "little guy" vs. "big guy" clash. According to them, the new rules will drive small traders out of the business, while doing nothing to touch larger traders who don't use the retail market.

  • It's Un-American
    One enraged commentator on the CFTC site compares it almost to a second American revolution. "Please do not let the big boys have all the pie. We live in this country because we have the freedom to choose. Patrick Henry once closed with the old famous line "give me liberty or give me death." I couldn't agree more."

  • The Proposal Will Be Ineffective
    Others argue that limiting leverage will just drive traders to use retail brokers that are domiciled outside the United States. Since all this trading is done over the internet, this is a legitimate concern. This would also expose these traders to even less protection since in theory retail brokers outside the United States may not have to comply with disclosure and other requirements.

Is It Necessary?
One question that arises in the wake of the proposal is whether the rules are actually needed. There were no headline events in the forex market over the last three years that contributed to the financial crisis, and it certainly cannot be claimed that reducing leverage here would decrease the systemic risk to our financial system. (Learn more in Forex Leverage: A Double-Edged Sword.)

The CFTC is therefore attempting to institute regulatory safeguards to protect retail traders from themselves. When the commission published its proposed regulations, which included other new rules besides the leverage proposal, it noted that the retail forex market was rife with "a number of improper practices that have raised concern, among them solicitation fraud, a lack of transparency in the pricing and execution of transactions, unresponsiveness to customer complaints, and the targeting of unsophisticated, elderly, low net worth and other vulnerable individuals."

The leverage reduction is an attempt to limit the universe of individuals that are susceptible to these practices by making it more difficult to trade in the retail forex market. The theory might be that since less leverage is allowed, more money will be needed to trade effectively, and this may lead to a more financially sophisticated group that might not fall victim to the fraud that the CFTC claims is inherent in the retail forex market.

There might be some legitimacy to this argument as the CFTC has filed 114 forex enforcement actions over the last nine years, resulting in more than $1 billion in restitution and civil monetary penalties.

Bottom Line
The new rules proposed by the CFTC to lower allowable leverage are raising hackles all over the retail forex market. It remains to be seen if this is a solution in search of a problem, or a needed protection for unwary consumers.


Still feeling uninformed? Check out last week's Water Cooler Finance to see what's been happening in financial news.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Stock Analysis

    6 Risks International Stocks Face in 2016

    Learn about risk factors that can influence your investment in foreign stocks and funds, and what regions are more at-risk than others.
  3. Investing

    3 Things About International Investing and Currency

    As world monetary policy continues to diverge rocking bottom on interest rates while the Fed raises them, expect currencies to continue their bumpy ride.
  4. Investing News

    Tufts Economists: TPP Will Reduce U.S. GDP

    According to economists at Tufts University, the TPP agreement will destroy half a million jobs in the U.S. by 2025.
  5. Economics

    Governments Ask Tech Giants to Join War on ISIS

    In the US and Israel, governments have asked their respective nations' tech industries to help in the war against ISIS.
  6. Stock Analysis

    Analyzing Boeing’s Return on Equity (ROE) (BA)

    Learn about Boeing's return on equity and find out how the company's ROE compares to its own historical performance and aerospace industry peers.
  7. Forex Fundamentals

    How To Calculate An Exchange Rate

    An exchange rate is how much it costs to exchange one currency for another.
  8. Stock Analysis

    Analyzing Verizon's Return on Equity (ROE) (VZ)

    Learn about Verizon's return on equity and find out how ROE is influenced by net profit margin, asset turnover ratio and financial leverage.
  9. Wealth Management

    How to Invest Like a Millionaire in 2016

    Discover how to start 2016 strong by learning how to imitate the investing strategies that distinguish millionaire investors from most average investors.
  10. Economics

    4 Ways China Influences Global Economics

    Learn the four ways China's economy can influence the global economy. The recent decline in Chinese stock markets should be the least of your worries.
RELATED FAQS
  1. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
  2. Can mutual funds use leverage?

    Traditionally, mutual funds have not been considered leveraged financial products. However, a number of new products have ... Read Full Answer >>
  3. How do hedge funds use leverage?

    Hedge funds use several forms of leverage to chase large returns. They purchase securities on margin, meaning they leverage ... Read Full Answer >>
  4. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  5. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  6. How are NDFs (non-deliverable forwards) priced

    The price of non-deliverable forward contracts, or NDFs, is commonly based on an interest rate parity formula used to calculate ... Read Full Answer >>
Hot Definitions
  1. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  2. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  3. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  4. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  5. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
Trading Center