Retail traders enjoying the Forex market as it is easy to access the trading account online. Now with Internet access almost everywhere in the capitalist economies, trading becomes more and more popular. Globalization is the name of the 21st century. China is the world’s manufacturer, U.S.A. is the innovator, the European Union formed to compete with the two and with Russia… The same way one is looking at the global economy can be used to look at trading the Forex markets. When choosing a Forex broker to trade, one is not limited to the boundaries of its country/region, but, because of the Internet era we’re living in, can choose a broker from another part of the world. The criteria used to analyze the broker is the same, but some other jurisdictions may offer more advantages for the retail trader. If the broker is regulated and conditions to trade are met (segregated funds, funds safety, regulation, etc.), then Forex trading is not bound to any one physical location like a country or region. Having said that, the idea of this article is to discuss the advantages and disadvantages of trading Forex in offshore accounts. This means, opening a trading account in a different jurisdiction (country, continent, etc.), and trading it. What are the problems faced, if any, and why one should go down that path? The following are pros and cons for trading in an overseas account.
Pros and Cons of Trading in an Offshore (Overseas) Account
What would make someone to open a trading account in a different country/region? These days there are plenty of Forex brokers available in any country, so why bother to open a trading account somewhere else?
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Advantages of an Overseas Account
The answer to the two questions above is that some other jurisdictions may offer specific incentives that are not available in all regions. The classical example here comes from the United States. In the United States, the SEC (Security and Exchange Commission) forbids Forex brokers to allow their clients to hedge positions on the same account. As a short introduction, hedging means to open two trades on the same currency pair and with the same volume, in opposite direction. The idea or the argument the SEC brings to justify its decision comes from the fact that hedged positions are supposed to have a higher risk degree. Therefore, everything is being made on behalf of the client, to protect client’s interests. So far, so good. The problem, though, comes from the fact that there are wonderful hedging strategies that are working like a charm and US based traders cannot use them if the trading account is with a broker in the United States. To give you an example, imagine you have a trading strategy, one that is based on a technical setup (like trading an intersection point or a cross between two oscillators) and you apply it on the same currency pair, but on different timeframes. Therefore, such timeframes can be the daily, four hours, hourly and fifteen-minute chart. Or maybe even the five-minute chart, to make things even more interesting. Because timeframes are spread so widely, it is possible that at any one moment of time, to have a bullish signal on one timeframe and a bearish signal on another one. If you’re not allowed to hedge in your trading account, then you can’t take all those signals and may miss on some good profits. One way to avoid that is to open two distinct accounts with two different brokers, but this is both time consuming as well as resource wasting. Another way to avoid this is to open an offshore account. That is, a trading account with a broker that is not based in the United States, but it is regulated and all. Any profit made in an overseas account is not taxed unless the funds are withdrawn. If they are kept in the trading account, there is nothing to worry about. Still, on the same page, trading in offshore accounts opens the opportunity to have your trading account denominated in a different currency. For example, if your analysis on the medium to long term shows the Australian dollar is going to appreciate against the U.S. dollar, then it is wise to trade with an Australian dollar-denominated account. The next thing to do is to search for brokers that offer the possibility to open a trading account in this currency and open an account. This way, there is a win-win situation in the case market confirms your analysis and the AUDUSD pair is moving higher. On one hand, you’ll make a profit being right on the trade, and on another hand, you’ll profit from the fact that the Australian dollar appreciated against the U.S. dollar. This is just a small trick to profiting from favorable conditions that are available in a different part of the world. Another constraint in the United States is that trades need to respect the FIFO (First in First out) rule. This rule calls for the first trade that was open to being closed before any other trade on the same currency pair. While this should not have a significant impact on the overall performance, it is affecting the trader on a psychological level. Closing a trade that is in negative territory only to release some margin can be avoided by closing a positive trade opened later from a better level. This is not possible to be done if the account is mandatory to follow the FIFO rule. These things mentioned here are only a few that show the importance to have an open mind when choosing the broker to trade with.
Disadvantages of an Offshore Account
By far, the main disadvantage is the fact that there is a big risk that the broker is not regulated, whereas in the United States, for example, you can be sure that all brokers are regulated. This makes traders spending time and resources trying to find out about the brokerage business they want to open an account with, etc. The funny thing is that regulation is a positive thing both for the broker and trader, but unfortunately, it is not always understood the right way. Again, to avoid the constraints mentioned in this article, opening two or more trading accounts (even with the same broker) is recommended. While funds are being split, and therefore the available trading margin is split as well, it is better than not using hedging or being forced to follow the FIFO rule even when it doesn’t make sense for your overall strategy.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market. - Why Trading Forex?
– Advantages and disadvantages of trading the currency market, what are trader’s expectations and what is a realistic approach to follow - Technical Analysis – Support and Resistance Areas
– Defining what support and resistance areas are, how to find them using technical analysis and why traders are looking to buy into support and sell into resistance. - Opening a Live Trading Account
– Steps to open a live trading account with a Forex broker, starting with the time taken for the whole process, documentation to be sent, verification process, trading platforms to download, etc. - What are “Lots” in Forex Trading
– Explaining the concept of a lot of Forex trading, and from that heading to micro-lots, different trading accounts, and broker’s limitations. - Volume and Slippage – Value of a Pip and Execution Types
– Execution is important to every Forex trading and this article deals with the difficulties to trade big volumes with little or n- slippage.
Other Educational Materials
- Foreign exchange trading in emerging currencies: more financial, more offshore. McCauley, R.N. and Scatigna, M., 2011.
- Global current account imbalances and exchange rate adjustments. Obstfeld, M. and Rogoff, K.S., 2005. Brookings papers on economic activity, 2005(1), pp.67-146.
