You are mostly correct. If you only set the three player limit for the matchsquad for your national competition and cup matches, the game will say, OK, so I can play players? Sure, but I will make sure I still have all the best players I can get. You can still end up with 6-10 foreign players that way. That's why I also set the 3 player limit for the complete squad. This works reasonably well, but also needs you to clean up squads. Otherwise the players just get stuck in their teams.