Do you know how "FIFO" work in forex trading?

What does mean by FIFO?

Definition of FIFO. The accounting term "First In First Out," or FIFO, refers to the practice of handling items that appear in a queue. This standard will be followed by a broker in forex trading to decide how to close open positions. Each open position within a given currency pair is closed out in the sequence in which it was first opened. 

The "LIFO," or Last In First Out, convention is the opposite. All positions would be treated according to this rule, clearing the last item first. Most of the time, FIFO is the method that is more appropriate. When sorting data, LIFO is frequently employed in computer programs.

I am a forex trader. And I traded with assetsfx.org, but in their trading terms and conditions, they don’t apply FIFO rules. But it’s important to know how FIFO plays a role in forex trading and whether it is worth it. In this article, I am trying to uncover the overall facts of FIFO for trading.

Let's start…….

The FIFO Rule: What is it?

FIFO stands for "First In, First Out," first of all. Rule 2-43b, which was released by the National Futures Association (NFA) and went into effect in May 2009, is based on this policy. In essence, the FIFO rule requires traders to close off the first trade before starting a new one with the same pair and size. It applies to all brokers based in the US who are subject to NFA regulation.

What is the FIFO rule's application to forex trading?

By using an example, it is simplest to understand how the FIFO rule functions in forex trading. Consider using a scaling method to trade GBP/USD. 

You would open three long positions on GBP/USD at three separate entry points:

1st Position:

On February 1st, a long position of 100,000 units in GBP/USD was initiated at 1.6000.

2nd position:

On February 2nd, I started a 100,000 unit long position in the GBP/USD exchange rate.

3rd Position:

On February 3rd, I started a 100,000 unit long position in the GBP/USD currency pair.

Total position

In GBP/USD, 300,000 units are long.

In that situation, if on February 4th the GBP/USD swings back to 1.6100 and you wish to liquidate 100,000 units of your total position, then in accordance with the FIFO rule, you must close the 100,000 units that you initially purchased at 1.6000. If you want to close the 100,000 units that you opened at 1.6100 in your second position, the broker won't let you.

If you have multiple positions in the same currency with different position sizes, the same reasoning still holds true. Look at the illustration below:

1st Position:

On February 1st, a long position of 100,000 units in GBP/USD was initiated at 1.6000.

2nd position:

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

3rd Position:

On February 3rd, I started a 100,000 unit long position in the GBP/USD currency pair.

4th Position:

On February 4th, I started a 75,000 unit long position in the GBP/USD exchange rate.

Total position

In GBP/USD, 300,000 units are long.

According to the FIFO rule, if you place a market order to close 25,000 units, it will be filled from Position 1 because it is the first or oldest position you have opened. Similar to this, if you place a market order to close 150,000 units, the figure will be taken first from the oldest deal, resulting in 75,000 units in Position 3 and 75,000 units in Position 4.

Remember that in this position, even if you don't have any additional positions with the same size, you are still permitted to manually close Positions 2 and 4. However, the platform will inform you that you must close Position 1 before closing Position 3 manually.

Since you must close the first position before initiating a new position with the same trading size and currency pair, the FIFO rule also applies to hedging. Simply put, the broker won't let you open two or more opposing positions on the same currency pair at once. Therefore, you cannot initiate a new short position on the same pair and size as your open long position in GBP/USD until the long position has been terminated.

Which brokers are covered by FIFO?

You probably feel the effects of this if your broker, like Oanda, is governed by the NFA. Actually, FIFO is already commonly utilized by stock and futures platforms, while forex platforms have only recently begun to do the same (August 2010).

Exactly why you might prefer the first-in, first-out method?

• It's easy to understand.

It's as simple as selling shares in the same order that you bought them.

• You can take a backseat.

We will automatically sell the oldest shares first, so you don't need to manually choose which shares to sell.

Benefits of the FIFO method

The following benefits for corporate organizations come from using the first in, first out (FIFO) method of inventory valuation:

• Because the cost is based on the most recent cash flows from purchases that are used first, the FIFO method saves time and money when determining the exact cost of the inventory that is being sold.

• It is an easy idea that is straightforward to understand. Even a layperson can understand the concept with minimal explanation. It would be simple enough for managers with little to no accounting knowledge to understand.

• It is a reasonably realistic strategy to employ since FIFO solves the problem of sometimes being unable to determine the costs of the goods sold at the point of sale.

• Because it is a commonly used and established method of valuation, it is more consistent and comparable.

• Because there is no longer any ambiguity regarding the values to be utilized in the cost of sales figure of the profit/loss statement under the FIFO policy, it is more difficult to manipulate the income shown in financial statements.

• In times of rising product pricing, FIFO will demonstrate improved gross and net profitability.

• The cost of sales is determined by opening stock, purchases, and closing stock.

• This is so that the profits reported would be higher because the "cost of sales" is actually the figure of inventory, and during inflation, first inventories will have less cost than recent stocks.

Drawbacks of the FIFO method

The following list includes the main drawbacks of the FIFO inventory valuation method:

• The fact that the FIFO method of inventory/stock valuation produces higher earnings during periods of inflation and higher "Tax Liabilities" as a result is one of its main drawbacks. As a result of tax charges, it can lead to higher cash outflows.

• FIFO might not be an appropriate measurement during periods of "hyper inflation." In these circumstances, there is no predictable pattern of inflation, and product prices could increase significantly. In such circumstances, it would not be fair to match the majority of previous purchases with the most recent sales and could inflate earnings to offer a skewed picture.

• If the resources or items you buy have changing prices, FIFO is not the right measurement for you since it could lead to inaccurate earnings for the same time because different costs for the same goods within the same period are recorded.

• Even though the FIFO price valuation method is easy to understand, it can be difficult to use and extract the costs of items since a large amount of data is needed, which can lead to administrative mistakes.

• FIFO is predicated on the rates of inflation, just like any other pricing method. This oversimplifies the cost calculation because costs may also take into account the effects of numerous other variables, such as supply and demand, transfer pricing, foreign exchange fluctuations (in the case of purchases made abroad), etc. Accordingly, inventory valuation must take into account all pertinent variables involved.

Last Words

The FIFO rule forbids price adjustments to execute customer orders, unless they are used to address a complaint that is in the client's favor. This is in addition to forbidding traders from opening numerous positions of the same currency pair that could offset one another. The rule also restricts modifications to a few straight-through processing transactions. This means that before any changes are made, the NFA must evaluate, approve, and record them.

The FIFO rule is ultimately a component of the government's effort to regulate the forex market in order to ensure honest and ethical business practices between traders and trading organizations. We must understand that regulators just aim to safeguard ordinary traders in order to provide a more level trading field for internet trading.

There are certain legitimate ways to avoid the FIFO rule if you are a US-based trader who understands how to profit from hedging strategies. What you need to keep in mind is that these techniques are thought to be rather sophisticated and might not function in every broker.

For these reasons, before spending real money in it, be sure to first learn the fundamentals, create a solid trading strategy, and don't forget to test them in a demo account.