How To Choose a Forex Broker - Part 1

[Igor 10]

As of January 2012, foreign exchange market accounts for more than $4 trillion in average traded daily value, making it the largest financial market in the world. No central marketplace exists for the forex market; rather, traders must conduct their trading activities through forex brokers. An increasing number of forex brokers are available, and traders should take the time to research, evaluate and compare options to find the broker that best fits their needs. This guide will explore the various important considerations when choosing a broker in today’s competitive forex marketplace. (In this article we’ll look at five considerations when choosing a forex broker.

 

Broker Basics

• Regulation. A reputable forex broker should have rules, programs or services to protect the integrity of the market. They should protect the public from fraud, manipulation and abusive practices related to the sale of futures and options and to encourage open, competitive and stable futures and options markets. In the U.S. brokers would be registered with the U.S. Commodity Futures Trading Commission (CFTC) as a Futures Commission Merchant and Retail Foreign Exchange Dealer, and will be a member of the National Futures Association (NFA.)
   
   
  
• A professionally looking website does not imply or guarantee that a broker is reputable; reputable brokers will state these affiliations on their websites, typically in the “About Us” section and on each web page. Each country outside of the U.S. has its own regulatory body which traders can research.
   
   
  
• Location. In the Internet age, there may not be any reason to visit a brick and mortar office, but the location of a forex broker remains a consideration primarily because of regulation and potential educational opportunities. A broker that is located in a country that provides little regulation may be a riskier place to open an account than one located where regulatory compliance and enforcement have a strong presence. A trader who deals with a broker that is regulated has some recourse in the event that there is a problem with the broker: the trader can contact the appropriate authorities to file a complaint and seek a resolution. In addition, the location of some brokers (such as those with regional or local offices) may allow traders to attend in-person training seminars or workshops that can assist with learning trading concepts.
   
   
  
• Year Founded. When a broker became established may help confirm the professionalism and durability of the broker. There have been instances where fly-by-night brokers have either acted in a fraudulent manner or simply had poor business practices, and ended up closing shop after a short stint. While all brokers have to start out as new companies, those who have been around for a few years or longer gain credibility since a fraudulent or badly managed firm is unlikely to remain in business.
   
   
  
• For U.S. Clients, they should accept U.S. Clients. In response to increased regulation brought on by the Dodd-Frank Act, many International Forex brokers have stopped offering services to U.S. clients. Foreign affiliates of U.S. based brokers can service U.S. retail customers only if they are registered with the CFTC and comply with the new CFTC leverage rules. Currently, the maximum leverage for U.S. retail clients is 50:1 for major currencies, and 20:1 for minors. Restricted leverage ratios are intended to protect both firms and clients from unnecessarily large losses resulting from over-leveraged positions. Due to concerns over possible legal issues, many brokers have opted to simply drop out of the U.S. retail market.
  

 

Platforms & Account Details

• Trading Platform. The trading platform is the trader's portal to the markets. With this in mind, traders should ensure that the platform and any software is easy to use, visually pleasing, and has a variety of technical and/or fundamental analysis tools. Perhaps most importantly, trades should be able to be entered and exited with ease: a well-designed trading platform will have clear buy and sell buttons, and some may even have a "panic" button that immediately closes all open positions. Figure 1 shows an example of an order entry window that has clear, easy-to-use order entry buttons. A poorly designed interface, on the other hand, could lead to costly order entry mistakes, such as accidentally adding to a position rather than closing it, or going short when a long trade was intended. Other considerations include customization options, order entry types, automated trading options, strategy builders, backtesting and trading alerts. (Learn how to set each type of stop and limit when trading currencies.
   
   
  
• Typical EUR/USD Spread on Standard. Brokers typically make their money on the spread; that is, the difference between the bid and the ask price. A EUR/USD quote of 1.3943 - 1.3946 has a 3 pip spread. That means that as soon as a market participant buys at 1.3946, the position has already lost 3 pips of value since it could only be sold for 1.3943. Typically, the majors, which include the US Dollar/Japanese Yen (USD/JPY), the Euro/US Dollar (EUR/USD), the US Dollar/Swiss franc (USD/CHF), and the British Pound/US Dollar (GBP/USD), trade with greater liquidity and tighter spreads, but the various brokers can determine the spread for each currency pair. A typical spread for the EUR/USD currency pair traded on a standard account might range from 1-2 pips. Many brokers, however, reward their standard account clients with tighter spreads, and some offer premium accounts with even more favorable spreads.
   
   
  
• Typical EUR/USD on Micro. Since micro accounts are the smallest accounts, brokers may utilize a wider spread to try to make money. While the spread varies from broker to broker, forex traders could expect to see spreads of 2-3 pips, though some brokers do offer the same spreads on both standard and micro accounts. In addition, some brokers state in their fine print that during times of increased market volatility, such as during the release of important economic or political news, the spread on micro accounts for certain pairs can be raised.
   
   
  
• Number of Pairs Offered. While there are numerous currencies available for trading, only a few get the majority of attention, and therefore, trade with the greatest degree of liquidity. The majors (USD/JPY, EUR/USD, USD/CHF, and GBP/USD) tend to trade in more predictable movements and ranges; however, many more currency pairs are traded. A broker may offer a huge selection of forex pairs, but what is most important is that they offer the pair(s) in which the trader is interested.
   
   
  
• Demo Account. Most brokers offer free demo accounts so traders can test drive the trading platform prior to opening and funding an account. This is important for several reasons. First, it gives traders the opportunity to use the platform to determine if it is intuitive, robust and user-friendly, or complicated. Secondly, using a demo account allows traders to practice making trades before money is on the line. This is particularly important in regards to entering and exiting trades, as well as placing profit target and protective stop loss orders. Order entry mistakes – pilot error – can be extremely costly, and the best way to avoid these types of losses is to practice with a demo account, with no money on the line. Lastly, a demo account affords the trader the opportunity to learn the subtle tricks of a platform, which can increase efficiency in real trading. Knowing that a simple right-click of the mouse can close all open positions instead of having to go into a menu and sub-menu can save time and money.
   
   
  
• Maximum Leverage. Forex traders have access to a variety of leverage depending on the broker and the country where the broker is located. Leverage is represented as a ratio; for example, leverage could be 50:1 or 200:1. Leverage is a loan extended to margin account holders by their brokers. Using 50:1 leverage, for example, a trader with an account size of $1000 can hold a position that is valued at $50,000. Leverage works in a trader's favor with winning positions since the potential for profits is greatly enhanced. Leverage can, however, quickly destroy a trader's account since the potential for losses is magnified as well. Because leverage can cause catastrophic losses, it should always be used judiciously.
   
   
  
• Minimum Standard Account Deposit. Standard accounts are appropriate for experienced and/or professional traders, and trade with a standard lot, or contract, size of 100,000 units. A one-pip change in a currency pair is equal to $10 for EUR/USD. While many brokers require a minimum deposit of $10,000, others do offer lower deposits of $3,000 or even $1,000. With leverage, of course, the buying power is much greater than the minimum deposit, which is one reason forex trading is so attractive to traders and investors.
   
   
  
• Minimum Micro Account Deposit. A micro account allows forex participants to trade in much smaller increments than a standard account. A micro lot is equal to 1,000 units of the base currency, compared with a standard lot’s 100,000 units. A one-pip change in a currency pair traded in a micro account equates to a $0.10 change for EUR/USD. Mini-accounts are also available that have a size of 10,000 units of the base currency, and where a one-pip fluctuation is equivalent to $1 for EUR/USD. Designed for new traders, micro accounts are appropriate for traders who want to trade with less of an investment, or who are ready to put real money on the line – just not a lot of it. As traders gain confidence, more lots can be added to increase exposure. Many brokers allow traders to open micro accounts with as little as $5. It should be noted that some brokers offer micro accounts as “self-service” accounts, and no telephone or chat support is provided. All support is conducted through e-mail, FAQs and an online trading community.
   
   
  
• Mobile Trading. Mobile forex trading is increasingly important to traders on the go, and provides a convenient means of staying on top of the markets. Many of the larger and reputable brokers offer the ability to access charts and trade entry windows via applications designed for the iPhone/iPad or Android operating systems. Typically, these applications are included free of charge with a funded trading account.
  

 

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