Choosing a good forex broker is one of the most important decisions you need to make at the beginning (or at any point) of your forex trading career. Do not take this decision lightly, but at the same time don’t stress over it – the process does not need to be complicated – just like in your trading decisions, once you do your homework, things tend to fall into place. Chance favors the prepared trader and everything you need to make an informed decision is listed right here. All you have to do is follow the advice given and you will find yourself a broker that suits your needs. If you are not familiar with what is available, you can have a look at the brokers we have listed in our Broker Reviews section to familiarize yourself with who is who in the forex world. If you have already narrowed down your search to just a few, or even one broker, and want to be sure that they are in fact what you want, then keep reading.
Regulation (the "Legitimacy Test")
The first thing you need to do is check whether the broker is regulated. The fact that the forex market itself is not regulated opens the door to a lot of possibilities for a scheming mind. There are shifty brokers out there, ranging from outright scams to just badly run businesses which are not accountable to any regulatory body. The brokers who are regulated choose to be so, in order to add a layer of legitimacy to their reputation. Please do NOT fund any accounts with an unregulated forex broker. There are not many good reason to do so, and plenty of reasons not to. It just makes sense.
By far the most respected regulatory bodies are the US-based National Futures Association (NFA) and Commodity Futures Trading Commission (CFTC). Most forex brokers, even if they are not based in the United States, are members of the NFA and registered Futures Commission Merchants (FCMs) with the CFTC. The UK based Financial Services Authority (FSA) is also a well respected regulating body, as is CySEC (Cyprus), ARIF (Switzerland), ASIC (Australia) and SFC (Hong Kong) among others. Just because a firm writes on their website that they are regulated however, does not make it so. Always check the websites of the regulating bodies themselves – they all offer a searchable database that allows visitors to find regulated members by name:
NFA/CFTC: http://www.nfa.futures.org/basicnet/
FSA: http://www.fsa.gov.uk/register/home.do
ARIF: http://www.arif.ch/en/membres.htm
CySEC: http://www.cysec.gov.cy/licence_members_1_en.aspx
ASIC: http://www.search.asic.gov.au/gns001.html
SFC: http://www.sfc.hk/sfcprd/eng/pr/html/PR002.jsp?charset=ISO8859_1
It is also important, particularly for US-based forex brokers, to be well capitalized. Well capitalized companies tend to be much more stable and less prone to insolvency. This is particularly true in the US because brokers here are not required to keep client funds segregated from company operating capital, so clients are at increased risk in case of insolvency. For CFTC registered FCMs, you can look up the broker’s operating capital:
http://www.cftc.gov/marketreports/financialdataforfcms/index.htm
Furthermore, if the broker does keep client funds segregated, it is certainly a bonus, since it provides additional protection of client funds even in case of insolvency. FSA regulated brokers, for example, are required to keep client funds segregated. This of course begs the question, where are the funds being kept? Are they in a safe account at a large bank or some dodgy private bank in the Cayman Islands? You can find answers to these questions in our broker reviews section. Alternately, the broker’s customer support should be able to answer these questions. If they cannot, they may be hiding something (or the customer service rep may simply be incompetent - either way it's not a good sign).
Finally, as far as legitimacy is concerned, it is always prudent to check the WHOIS database for the broker's domain name. If the contact information they provide is misleading, such as a virtual office, or hidden using a privacy protection service such as PrivacyProtect.org, it should immediately raise flags. Any serious business should freely display their real contact information instead of hiding it.
Timeframes
OK, so your broker has passed the “legitimacy test”. They are regulated, well capitalized, and they don’t mix client funds with operating capital. Now it’s time to make sure that they provide the type of trading conditions that suit your trading style. Depending the timeframes that you trade, it may be important for spreads/commissions to be very low. Also, if you trade very short timeframes (scalping) you should make sure that your broker doesn't have a problem with that. Generally, brokers who are market makers will have a problem with it, while brokers that use straight-through processing or actual ECNs generally don't mind. Please read our "ECNs vs. Market Makers" article if you are not sure what that means. If you are a day trader, then your transaction costs can make you or break you. If you enter and exit the market several times per day, these costs really add up. Consider, for example, that you are trading 1 mini lot (10,000), 5 trades per day on EUR/USD. If the spread your broker offers you is 3 pips on average, then you are paying $3 per trade, $15 per day, $300 per month etc… you get the picture. If you instead had a broker that offers you an average spread of 1 pip on EUR/USD, then you would be paying $1 per trade, $5 per day, $100 per month! That’s a difference that anyone serious about their business should not ignore.
On the other hand, if you are a position trader, who makes 5 trades per year, then the difference amounts to only $10 per year. This is minimal and may very well be outweighed by other factors, such as perhaps higher overnight interest rates in a carry trade strategy, or better customer support or some other factor that gives you more than $10 of value added with the higher spread broker. So neither broker is better or worse, they are just better suited to different styles of trading.
Automated vs. Discretionary Trading Styles
Some broker platforms are also better suited to automated trading. For example, MetaTrader 4 (MT4) is a favorite among retail traders who program their own “Expert Advisors” or “EAs”. If that’s you, then this could be a determining factor when choosing a broker. On the other hand, if you are a discretionary trader who bases trading decisions on a combined technical and fundamental analysis approach, then it may not matter to you whether the broker offers MT4 or not, as long as the platform offers you good charting. You can visit our broker reviews page for details on which brokers use which specific trading platforms.
Islamic Swap-Free Accounts
Another factor could be a broker’s choice to offer Islamic accounts, which do not charge or pay any rollover or swap interest. Traders bound by Sharia Law are not allowed to conduct any business dealing with interest, so some brokers may be off your list as a result. Many brokers offer swap-free accounts, but many also do not. Moreover, some brokers that do offer swap-free accounts may do so only under certain conditions (read extra fees), since such accounts are susceptible to abuse, and brokers are very much aware of that.
It should also be noted that the brokers who do offer swap-free accounts to all their traders, with no extra charges, are a great choice for non-Islamic traders as well, if they simply want to short the carry trade - just be careful, as most such brokers are not regulated.
Tradable Instruments
Finally, when it comes to trading style, some forex brokers have a much wider range of tradable instruments than others. In addition to the major currency pairs, some brokers allow you to trade exotic pairs (such as PLN/SGD or Polish Zloty vs. Singapore Dollar) Gold, Silver, Oil or any number of other instruments. You may or may not find these of interest, but if you do, then going with a broker where you can trade your desired instruments is a must.
Minimum deal sizes
Another concern, particularly for smaller accounts, is minimum deal sizes. Some brokers only allow you to trade standard lots (100,000), which does not give someone with a $5,000 account very much flexibility when it comes to money management. Money management is a very important aspect of any trading strategy, and the finer “resolution” you can get when calculating deal sizes, the more accurately your money management calculations can be reflected in reality. This is an often overlooked or at least underestimated factor when it comes to choosing a broker, but it is absolutely critical. The best choice for small account holders are the brokers that offer traders deal sizes as small as 1 unit, giving traders maximum flexibility when choosing the size of their trades and positions.
Leverage
In contrast, an often overestimated factor involved in the appropriate choice of a broker is maximum leverage allowed by the broker. Most forex brokers have a margin requirement of 1% or even lower, which allows for 100:1 maximum leverage – more than enough for any sensible trader, and yet some traders insist on ridiculously low 0.25% margin requirements resulting in 400:1 maximum leverage. This has been the highway to ruin for most who have tried to use anywhere near that much leverage. You don’t have to be a genius to see why, since leverage multiplies your losses as much as your wins. All it takes is a small losing streak and your account is blown. In any case, this is not a lecture on the pitfalls of high leverage. We can address that in another article. Suffice it to say that low margin requirements and the resulting high maximum leverage should NOT be a big factor when choosing your forex broker, with one notable exception. Some traders may feel that it is better to keep only a small percent of their total trading capital with their broker, preferring instead to hold most of it in a bank account where it is insured and collecting interest, while using high leverage to make up for the "shortfall" in their broker account. If the trading account then experiences a drawdown, it can always be topped up from the main pool. This is somewhat more complicated, and can be more costly due to more transactions being made between accounts, while the delay between getting funds from the bank account to the trading account can also be an added cost. The benefits of this do outweigh the downsides for some traders though, particularly ones who have a significant amount of trading capital and do not trade intraday, because the transaction costs and delays then end up being negligible as compared to the total amount of capital and the average timeframe of open positions.
Customer Support
One way to get a glimpse inside your forex broker’s business is to contact their support staff by a variety of methods. Send emails, use live chat, call them, get them to call you, whatever. No matter how small or irrelevant your questions may seem, they are important. Not only because you are a potential customer and you deserve their time and attention, but also because it allows you to judge how committed they will be if you do open a real account with them. If they are unable or unwilling to spend time with you to answer your questions now, then they most likely won’t act any differently after they have received your money. I encourage you to ask as many questions as you can think of, sometimes even ones you know the answers to, just to see if they will lose patience with you or refuse to answer questions that may seem obvious, or that expose their weaknesses. Some brokers get defensive when you ask them about regulation, for example – not a good sign. Make sure you also ask some tough questions about their internal systems, such as how they process orders, if they offset client orders in a higher tier or if they are the counterparty to clients’ trades, ask them about their liquidity providers, withdrawal fees etc (if you are not sure what these things mean, please refer to our "How Forex Brokers Work" article). These are all things that a client has the right to know. Any decent broker has to respect that and give you the answers. There is no reason not to, unless they have something to hide. It is also a good idea to keep a record of all your correspondence with your broker, just in case some disagreement arises in the future.
Test-run the Platform
All forex brokers nowadays offer traders the ability to test their trading platform with a demo account. Before funding a real account, it is highly recommended that you do this. It will give you an idea of how the platform performs. Are there any glitches? Is it stable? Is it fast? Is it easy to use? Is the charting package any good? Does it have the features I need? These are all questions you can answer very quickly when trading on a demo account. What you cannot know from trading a demo account, unfortunately, is how order execution will be on a real account. Execution is always flawless on demo, but this is not representative of the real market and can be vastly different if/when you make the switch to real market conditions. It is also not possible to withdraw the money from a demo account (very unfortunate), so you cannot judge how quickly these are normally processed. The same goes for deposits. The best way to get an idea of this is to have a look at our broker reviews page, where we have tested each broker with a real money account, and given them a 0-5 rating on how good their order execution is, how quick their transaction processing is, and a number of other important facts.
How we can help
We built a broker review section that is specifically designed with the above criteria (and more) in mind. We have listed all the information you could possibly want to know about each broker in order to help you choose the right broker for your individual needs. This is the most detailed information you will find anywhere, because we have thoroughly tested each broker with real money accounts. We keep adding new broker listings all the time, so check back every once in a while. We hope you find it useful.
miercuri, 29 februarie 2012
marți, 21 februarie 2012
How Forex Brokers Work
Like any other business in the history of business, your broker’s raison d’etre, is to make as big a profit as possible. There are about as many ways to go about this as there are brokers. For those who are in it for the long haul, however, it is generally best to adopt a set of practices which are deemed fair by their clients: certain boundaries are set, and operating beyond them can cost a brokerage its reputation, and along with it its clients. Straying outside these boundaries, therefore, is not considered as being in line with the long term goals of the business. How strictly these boundaries are enforced, especially when there is little chance of clients ever even becoming aware of any transgression, again varies from business to business. For the sake of simplicity, in this article we assume that everyone in the business is squeaky clean, as if every client could peek into the broker’s back office at any time and dissect every trade. This is obviously not the case, and many brokers do take advantage of this opaqueness, but the details of that are best left for another discussion.
So without further ado, let’s get into the details of how forex brokers function. Somewhat removed from the top-tier interbank market, retail forex brokers are there to provide a service that would otherwise not be available, that is, giving an investor with a $10,000 bankroll the chance to speculate in the up-until-recently very exclusive forex market. There are generally considered to be 2 types of brokers providing access at the retail level: Electronic Communications Networks (ECNs) and Market Makers. ECNs are generally somewhat more exclusive, requiring larger deposits to get started, but are seen as providing more direct access to the interbank market. As we will see, there are certainly advantages to this, but some disadvantages as well. Market makers, on the other hand are more often than not, the counter party to their clients’ trades, creating somewhat of a conflict of interest, whereas ECNs profit from commission fees charged directly to the clients, regardless of the result of any trade, they are seen as being completely impartial – an ECN has no incentive for a client to lose money. In fact, one could argue that an ECN stands to profit more if a client is successful, meaning that s/he will stay around longer and they will be able to collect more commission fees from them. A market maker, on the other hand, being the counterparty to a client’s trade, makes money if the client loses money, providing an incentive for some shady practices, particularly in an unregulated market. The extent to which this happens varies among individual brokers. There are also some benefits to trading with a market maker (see our ECNs vs. Market Makers article) Some brokers also provide a service that doesn’t quite fit into either category – they route different orders differently, depending on complex algorithms, or on a dealing desk, that analyze each order and attempt to fill it in the way that will be most beneficial to the broker’s bottom line. They can offset some client orders against one another, effectively creating an in-house market, they can choose to be the counterparty to a client’s trade (trade “against” the client), or they can offset their position with a hedge through a higher-tier counterparty. Note that the market maker is mainly concerned with managing its net exposure, and NOT with any single individual’s trades. They are NOT gunning for your stop losses specifically, but may be gunning for clusters of stops.
If you have already read the first article in the series, Structure of the Forex Market, you will recall that market mechanics are responsible for the variation in bid/ask spreads, and also for slippage. So it seems the two biggest novice traders’ pet peeves are not so much a function of who their broker is, but rather their lack of understanding of the way the forex market operates. A broker that offers a fixed spread tends not to fill orders during periods of low liquidity because this would expose them to undue risk, and as much as their job is to cater to their clients, remember they are in business primarily to make money for themselves. Some brokers also offer guaranteed order fills, such as “guaranteed stop losses”. Again, if there is no counter party to take the trade, they have to expose themselves to risk in order to fulfill this guarantee, so don’t be surprised if you see such a broker quoting different/delayed prices around important trend lines or support/resistance levels. Be especially aware of brokers who offer both guaranteed fills AND fixed spreads. When a broker offers something that seems too good to be true, you would be wise to question how exactly their business model is able to support such a risky practice. As a general rule, a broker will help you only when your interests are aligned with theirs. On the other hand, brokers provide a very valuable service, without which you wouldn’t have the opportunity to profit from the forex market, so please think about how it all comes together before blaming your broker for everything.
So without further ado, let’s get into the details of how forex brokers function. Somewhat removed from the top-tier interbank market, retail forex brokers are there to provide a service that would otherwise not be available, that is, giving an investor with a $10,000 bankroll the chance to speculate in the up-until-recently very exclusive forex market. There are generally considered to be 2 types of brokers providing access at the retail level: Electronic Communications Networks (ECNs) and Market Makers. ECNs are generally somewhat more exclusive, requiring larger deposits to get started, but are seen as providing more direct access to the interbank market. As we will see, there are certainly advantages to this, but some disadvantages as well. Market makers, on the other hand are more often than not, the counter party to their clients’ trades, creating somewhat of a conflict of interest, whereas ECNs profit from commission fees charged directly to the clients, regardless of the result of any trade, they are seen as being completely impartial – an ECN has no incentive for a client to lose money. In fact, one could argue that an ECN stands to profit more if a client is successful, meaning that s/he will stay around longer and they will be able to collect more commission fees from them. A market maker, on the other hand, being the counterparty to a client’s trade, makes money if the client loses money, providing an incentive for some shady practices, particularly in an unregulated market. The extent to which this happens varies among individual brokers. There are also some benefits to trading with a market maker (see our ECNs vs. Market Makers article) Some brokers also provide a service that doesn’t quite fit into either category – they route different orders differently, depending on complex algorithms, or on a dealing desk, that analyze each order and attempt to fill it in the way that will be most beneficial to the broker’s bottom line. They can offset some client orders against one another, effectively creating an in-house market, they can choose to be the counterparty to a client’s trade (trade “against” the client), or they can offset their position with a hedge through a higher-tier counterparty. Note that the market maker is mainly concerned with managing its net exposure, and NOT with any single individual’s trades. They are NOT gunning for your stop losses specifically, but may be gunning for clusters of stops.
If you have already read the first article in the series, Structure of the Forex Market, you will recall that market mechanics are responsible for the variation in bid/ask spreads, and also for slippage. So it seems the two biggest novice traders’ pet peeves are not so much a function of who their broker is, but rather their lack of understanding of the way the forex market operates. A broker that offers a fixed spread tends not to fill orders during periods of low liquidity because this would expose them to undue risk, and as much as their job is to cater to their clients, remember they are in business primarily to make money for themselves. Some brokers also offer guaranteed order fills, such as “guaranteed stop losses”. Again, if there is no counter party to take the trade, they have to expose themselves to risk in order to fulfill this guarantee, so don’t be surprised if you see such a broker quoting different/delayed prices around important trend lines or support/resistance levels. Be especially aware of brokers who offer both guaranteed fills AND fixed spreads. When a broker offers something that seems too good to be true, you would be wise to question how exactly their business model is able to support such a risky practice. As a general rule, a broker will help you only when your interests are aligned with theirs. On the other hand, brokers provide a very valuable service, without which you wouldn’t have the opportunity to profit from the forex market, so please think about how it all comes together before blaming your broker for everything.
joi, 2 februarie 2012
Structure of the Forex Market
The forex is unique among financial markets in a number of ways. One of these is that it was not traditionally used as an investment vehicle. It had, and still maintains to some extent, a somewhat more utilitarian purpose. In today’s globalized economy, most businesses have some international exposure, creating the need to exchange one currency for another in order to complete transactions. For example, Honda builds its cars in Japan and exports them to the United States, where an eager American buyer exchanges his dollars for a brand new Honda. Some of this money has to make its way back to Japan to pay the factory workers that built the car, but first those dollars have to be exchanged for Japanese yen, since that is the currency the Japanese factory workers are paid in. Transactions such as this are facilitated by international banks and are done through a mechanism known as the foreign exchange market, or forex. Since banks are used to facilitate these cross-border transactions, they naturally want to be paid for their services. This payment comes in the form of a bid/ask spread – offering to buy the desired currency at a slightly lower price than they are willing to sell it at, and pocketing the difference. Considering the fact that more than $3bn moves through the forex market daily, these seemingly small fees can add up to a significant sum.
Since the 1970’s most of the world’s major currencies have been on a (mostly) free-floating exchange mechanism, allowing for exchange rates to be determined by market forces, that is, supply and demand. I say “mostly” because there have been times when major central banks have intervened in the market to manipulate exchange rates by either buying or selling large amounts of their currency, but normally this only takes place in extreme situations. There are also other central banks that choose to manage their currencies much more strictly, but these are a minority in the developed world. So in most cases, this free-floating exchange rate mechanism allowed currencies to fluctuate against one another much more, and this in turn opened the door to speculation on the future movement of exchange rates. The banks’ intimate knowledge of the forex market, and their high level of capitalization allowed them to be the first to speculate in the forex market, and to significantly increase their profits by doing so. An unfortunate consequence of this speculation however was that liquidity at certain times became scarce, and some necessary transactions could not be completed. In order to solve this problem, banks turned to expanding the number of participants in the market to include non-banks, thereby generating sufficient order flow (liquidity distribution) to complete clients’ transactions, and also to profit from these newer and less knowledgeable market participants. These less experienced forex market participants first included large funds (such as the legendary Quantum Fund), but nowadays also include your local retail forex dealer.
Another unique feature of the forex market is that it is an over-the-counter (OTC) market, meaning that there is no central exchange (like a stock exchange) where transactions take place. Instead, top-tier transactions are made in the “interbank market”, which is a collection of the world’s largest money center banks, all free to trade currencies amongst each other at whatever rate they can agree on. Of course, it may be difficult to find your way around such a maze, so the brilliant minds at the leading banks developed the Electronic Broking System (EBS) to enable participants to easily see at what rates all the other participants are willing to deal at. A competing system was also developed by Reuters (D2). Today, one is preferred over the other mostly on the basis of which currency pair you want to trade, with EBS used mostly for EUR/USD, USD/JPY, EUR/JPY, USD/CHF and EUR/CHF, and Reuters D2 used for all other currency pairs. In 2006, EBS was acquired by ICAP. It should be noted that while these services provide a centralized structure for pricing information, they DO NOT constitute a centralized exchange. The forex is still very much an OTC market.
The 2nd tier of the market is made up of smaller bits of larger multinational institutions. This is when, for example, a bank branch in the US deals with another branch of the same bank in, say, Japan. So when you walk into your local branch and want to exchange currency, they will give you a quote which is not exactly representative of the interbank exchange rate. You are free to shop around for a better quote, and you would often be wise to do so, as rates can vary significantly from one bank to another.
Most retail forex brokers are a part of the 3rd tier, as they often deal with only a single 2nd tier liquidity provider. This is not always the case, as some retail brokers offer direct access to multiple liquidity providers, and are therefore themselves a part of the 2nd tier. This is particularly true of Electronic Communication Networks (ECNs), who normally route retail traders’ orders directly to the interbank market. For more information about how these differences affect retail traders, please read our article on How Forex Brokers Work.
Since the 1970’s most of the world’s major currencies have been on a (mostly) free-floating exchange mechanism, allowing for exchange rates to be determined by market forces, that is, supply and demand. I say “mostly” because there have been times when major central banks have intervened in the market to manipulate exchange rates by either buying or selling large amounts of their currency, but normally this only takes place in extreme situations. There are also other central banks that choose to manage their currencies much more strictly, but these are a minority in the developed world. So in most cases, this free-floating exchange rate mechanism allowed currencies to fluctuate against one another much more, and this in turn opened the door to speculation on the future movement of exchange rates. The banks’ intimate knowledge of the forex market, and their high level of capitalization allowed them to be the first to speculate in the forex market, and to significantly increase their profits by doing so. An unfortunate consequence of this speculation however was that liquidity at certain times became scarce, and some necessary transactions could not be completed. In order to solve this problem, banks turned to expanding the number of participants in the market to include non-banks, thereby generating sufficient order flow (liquidity distribution) to complete clients’ transactions, and also to profit from these newer and less knowledgeable market participants. These less experienced forex market participants first included large funds (such as the legendary Quantum Fund), but nowadays also include your local retail forex dealer.
Another unique feature of the forex market is that it is an over-the-counter (OTC) market, meaning that there is no central exchange (like a stock exchange) where transactions take place. Instead, top-tier transactions are made in the “interbank market”, which is a collection of the world’s largest money center banks, all free to trade currencies amongst each other at whatever rate they can agree on. Of course, it may be difficult to find your way around such a maze, so the brilliant minds at the leading banks developed the Electronic Broking System (EBS) to enable participants to easily see at what rates all the other participants are willing to deal at. A competing system was also developed by Reuters (D2). Today, one is preferred over the other mostly on the basis of which currency pair you want to trade, with EBS used mostly for EUR/USD, USD/JPY, EUR/JPY, USD/CHF and EUR/CHF, and Reuters D2 used for all other currency pairs. In 2006, EBS was acquired by ICAP. It should be noted that while these services provide a centralized structure for pricing information, they DO NOT constitute a centralized exchange. The forex is still very much an OTC market.
The 2nd tier of the market is made up of smaller bits of larger multinational institutions. This is when, for example, a bank branch in the US deals with another branch of the same bank in, say, Japan. So when you walk into your local branch and want to exchange currency, they will give you a quote which is not exactly representative of the interbank exchange rate. You are free to shop around for a better quote, and you would often be wise to do so, as rates can vary significantly from one bank to another.
Most retail forex brokers are a part of the 3rd tier, as they often deal with only a single 2nd tier liquidity provider. This is not always the case, as some retail brokers offer direct access to multiple liquidity providers, and are therefore themselves a part of the 2nd tier. This is particularly true of Electronic Communication Networks (ECNs), who normally route retail traders’ orders directly to the interbank market. For more information about how these differences affect retail traders, please read our article on How Forex Brokers Work.
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