Do you know how the forex trading term "FIFO" works?

What is the FIFO method?

 

FIFO Explanation. First-in, first-out, or FIFO, is an accounting phrase that explains the protocol for handling items in a queue. In forex trading, this convention determines the sequence in which a broker cancels open positions. All positions opened inside a certain currency pair are liquidated in the order they were opened. 

 

The opposite practice is "LIFO," which stands for "Last In First Out." Under this protocol, all positions would be handled by removing the most recent item first. FIFO is the superior method in the vast majority of circumstances. LIFO is utilized more frequently in computer applications during sorting tasks.

 

I am a forex trader. In addition, I traded with assetsfx.org, whose trading terms and conditions do not include FIFO rules. But it is essential to understand how FIFO affects forex trading and whether it is worthwhile. In this article, I will attempt to provide an overview of FIFO for trading.

 

Let's start…….

 

What exactly is the FIFO rule?

 

First, FIFO is an acronym for "First In, First Out." Rule 2-43b, which was issued by the National Futures Association (NFA) and went into effect in May 2009, is based on this policy. The FIFO rule compels traders to close the first trade of the same pair and size before opening a second trade of the same pair and size. It applies to all NFA-regulated brokers based in the United States.

 

How Does the FIFO Rule Affect Foreign Exchange Trading?

 

Observing an illustration is the simplest method to understand how the FIFO rule applies to forex trading. If you wish to trade GBP/USD using a scaling approach, you would start three long positions at three separate times and entry levels.

 

Position 1:

 

On February 1, we opened a 100,000-unit long position in GBP/USD at 1.6000.

 

Position 2:

 

Opened a long position of 100,000 units in GBP/USD at 1.6100 on February 2.

 

Position 3:

 

On February 3, we opened a 100,000-unit long position in GBP/USD at 1.6200.

 

Total position:

 

Long 300,000 units in GBP/USD.

 

Consequently, if the GBP/USD returns to 1.6100 on February 4 and you wish to sell off 100,000 units of your overall position, the FIFO rule requires you to close the 100,000 units that you purchased at 1.6000 in your initial transaction. The broker will not permit you to close the second position of 100,000 units opened at 1.61 per unit.

 

If you have multiple positions of the same currency with varying position sizes, the same logic applies. Examine the example provided below.

 

Position 1:

 

On February 1, we opened a 100,000-unit long position in GBP/USD at 1.6000.

 

Position 2:

 

Opened a long position of 25,000 units in GBP/USD at 1.6100 on February 2.

 

Position 3:

 

On February 3, we opened a 100,000-unit long position in GBP/USD at 1.6200.

 

Position 4:

 

Opened a long position of 75,000 units in GBP/USD at 1.6300 on February 4.

 

Total position:

 

Long 300,000 units in GBP/USD.

 

In accordance with the FIFO rule, if you intend to close 25,000 units with a market order, it will be taken from Position 1, as it is the first or oldest position you opened. Similarly, if you wish to close 150,000 units with a market order, the quantity will be pulled from the oldest deal first, resulting in 75,000 units in Position 3 and 75,000 units in Position 4.

 

Keep in mind that you are still permitted to manually close Positions 2 and 4 in this scenario, as there are no other positions of the same size. However, if you manually shut Position 3, the platform will inform you that Position 1 must be closed first.

 

The FIFO rule also applies to hedging, as the first position must be closed prior to initiating a second position with the same trading size and currency pair. The broker will not permit you to simultaneously open two or more opposing positions on the same currency pair. If you have an open long position in GBP/USD, you cannot open a new short position on the same pair and size until the long position has been closed.

 

 

Which brokers are affected by FIFO?

 

If your broker, like as Oanda, is subject to NFA regulation, it is likely that you are affected by this. In fact, FIFO is commonly utilized by stock and futures platforms, but it has only lately been adopted by forex platforms (August 2010).

 

Why you might prefer the first-in, first-out method?

 

• It is easy to understand.

Simply put, shares are sold in the same sequence in which they were acquired.
 

• You may be hands-free.

We will automatically sell the oldest shares first, so you do not need to choose which ones to sell by hand.

 

Advantages of the FIFO method

 

The advantages of the first-in, first-out (FIFO) method of inventory valuation for corporate organization are as follows:

 

• The FIFO method saves time and money when estimating the exact cost of the goods being sold because the cost is determined by the most recent cash flows of purchases that will be used first.

 

• It is a straightforward concept that is easy to understand. Even a layperson can comprehend the concept with minimal explanation. It would be easy to understand for managers with minimal or no accounting knowledge.

 

• It is a fairly practical method, as it can be difficult to determine the costs of things sold at the point of sale, and FIFO resolves this issue.

 

• It is a commonly employed and acknowledged method of valuation that enhances comparability and consistency.

 

• As per FIFO policy, there is no ambiguity regarding the values to be utilized in the cost of sales figure of the profit/loss statement, which makes it harder to manipulate income shown in financial statements.

 

• FIFO will result in increased gross and net profits during periods of rising commodity prices.

 

• Cost of sales = beginning stock plus purchases less ending stock.

 

• This is due to the fact that "cost of sales" comprises of inventory figures, and because initial stockpiles will have a lower cost than recent inventories during inflation, reported profits will be larger.

 

Disadvantages of the FIFO method:

 

The primary disadvantages of employing the FIFO inventory valuation method are outlined below:

 

• One of the greatest disadvantages of the FIFO method of inventory/stock valuation is that it results in higher earnings during periods of inflation, resulting in greater "Tax Liabilities." It may result in greater cash outflows due to tax obligations.

 

• In periods of "hyperinflation," FIFO may not be a viable metric. In such circumstances, there is no logical inflation pattern, and prices of items may increase dramatically. And in such instances, matching the majority of earlier purchases with the majority of recent sales would be inappropriate and could inflate earnings to offer an inaccurate picture.

 

• FIFO is inapplicable if the materials/goods acquired have variable pricing patterns, as this might lead to miscalculated earnings for the same time due to the recording of different costs for the same goods throughout the same period.

 

• Although the FIFO price valuation method is easy to understand, it can be difficult to run and extract the costs of items due to the large amount of data necessary, which can lead to clerical errors.

 

• As with any other pricing strategy, FIFO is based on inflation rates. This oversimplifies the calculation of costs, as the costs may also be affected by many other variables, such as supply and demand, transfer pricing, foreign exchange fluctuations (in the case of international purchases), etc. Consequently, inventory valuation must take into account all relevant factors.

 

Last Words

 

In addition to barring traders from opening numerous positions of the same currency pair that could offset one another, the FIFO rule prohibits price adjustments to execute client orders, unless they are used to resolve a complaint in the client's favor. Lastly, the rule restricts modifications to certain transactions with straight-through processing. This means that the NFA must first evaluate, approve, and document all modifications.

 

Ultimately, the FIFO rule is part of the government's effort to control the forex market in order to ensure that traders and trading firms conduct fair and ethical business. By protecting retail traders, regulators are merely attempting to understand a safer trading environment and make internet trading less lopsided.

 

If you are a US-based trader who understands how to profit from hedging strategies, there are legal ways to circumvent the FIFO rule. Keep in mind that these approaches are considered quite complex and may not work with every broker.

 

Before investing real money, ensure that you have mastered the fundamentals, developed a solid trading strategy, and tested them on a demo account.