Forex brokers range widely from the highly reputable and well regulated firms handling many accounts honorably, to those engaging in questionable pricing and order execution practices, to the outright frauds who are simply seeking to deprive you of your money as quickly as possible before you ever start trading forex.
Accordingly, it makes considerable sense as an important part of setting up your forex trading business to do significant
research in advance about a forex broker before sending them any money.
This will help you to avoid any potential problems arising with the use or return of your trading funds you might be considering depositing in an account with the broker. In this first article we go through what a broker is, how to check it out online and what regulation means. If you want to skip this, then go straight to the next article; dealing spreads provide incentives.
What are forex brokers?
Online retail forex brokers are financial institutions which act as an intermediary by executing trades on behalf of their individual clients in the forex market based on orders transmitted through an electronic trading platform connected to the Internet.
Most online forex brokers operate through websites which allow traders to execute forex trades electronically using either a proprietary trading platform or an independent forex trading platform such as MetaTrader4.
Besides providing their clients with forex execution and deal pricing services, forex brokers often offer useful market related and educational forex information to assist their clients in making their trading decisions. The market related information could consist of charting software or access to top financial news wires such as AP/Dow Jones or Reuters. Furthermore, many forex brokers also offer educational material on forex trading to help get inexperienced traders started.
In addition to newswires and educational material, some forex brokers will even provide clients with professional forex market commentary and expert interpretation of events which influence exchange rates. Typically, these market commentaries are disseminated online in either written content or video format and can be very useful to novice traders when produced by an experienced market professional.
The majority of online forex brokers make their commissions off of the bid/offer or dealing spread which their clients trade on. So, regardless of whether the client makes or loses money on a trade, the broker will have already been compensated for having executed the transaction.
Get Clear With Your Broker Before You Start Trading
Knowing as much as possible about your broker and the account you plan to open can save you a considerable amount of money and frustration in the long run. Choosing a reputable broker with a no requoting policy (more on this later) is a good place to start.
Be clear with the broker on the particulars of every facet of your account, including margin, leverage, lot sizes, etc. Ideally, you should feel completely comfortable with the terms and conditions of the trading account and that you will be treated fairly.
As with any contract, remember to read the fine print carefully and ask a customer service representative at the broker for clarification of any terms or clauses you do not understand.
Also make sure the forex broker you choose has all the necessary tools, such as a viable trading platform and efficient order execution to ensure that you get the most out of your trading experience and avoid any pricing issues that may arise.
Checking Out a Forex Broker Online - reputation matters
You can get a general idea about whether or not a broker has had problems with its clients in the past by reading reviews and comments made by other traders who have used the forex broker. For example, some traders may have posted their experiences with the broker on online discussion forums dedicated to forex.
For example, one discredited forex broker charged clients with a breach of their rules found in their terms and conditions. Specifically, the terms forbade "pip hunting" - a trading process that involves opening and closing a trading position within a very short period of time. They used this questionable clause to essentially invalidate all of the customer's winning trades.
Of course, the account holder was only notified of this apparent breach after having made a large sum of money in the trading account, only to have it taken away by the forex broker because they were seemingly engaged in "pip hunting" activity. Had the account holder only checked a few online discussion forums dedicated to forex scams, they would probably have discovered that this disreputable broker could not be trusted.
In general, seek to avoid brokers that have had significant pricing and account management issues or if it routinely engages in questionable broker practices like:
Front running (read more)
Forbidden strategy clauses
Performing this research before opening an account with a broker will allow you to better assess the overall reputation of the forex broker in advance. Read this article for a more extensive explanation of questionable forex broker practices.
Online research also represents a valid way to determine if the forex broker engages in any of the above questionable practices that may significantly affect the pricing and deal execution service you receive from the broker.
Perhaps the most important consideration when opening a new account with any broker is whether or not they are regulated and by which agency.
The main objective of financial regulatory agencies consists in keeping the dealings of financial institutions with the general public as honest and aboveboard as possible, as well as to protect the interests of individual retail forex traders.
The regulatory authorities also periodically review the books of forex brokers in order to make sure that the broker is maintaining the minimum capital requirements.
In the event of financial problems and legitimate verified customer complaints, regulating agencies will often intervene with appropriate legal deterrents to close down fraudulent operations and assist in recovering customer funds.
The National Futures Association or NFA regulates and keeps tabs on many commodities and forex brokers doing business with U.S. clients.
Furthermore, the Commodities Futures Trading Commission or CFTC also regulates U.S. brokerages and has been granted the authority to take legal action against any firm registered as a broker/dealer that may be suspected of violating any of the anti-fraud sections of the Commodities Exchange Act. If the broker is regulated by both the NFA and the CFTC, you stand a very good chance of starting your trading account with a reputable forex brokerage company.
Regardless of a forex broker not needing to register with the NFA unless dealing in the futures markets, many reputable forex brokers go the extra step and register anyway since it increases the scope of their potential business and gives them an additional degree of legitimacy.
Furthermore, forex brokers which are not based in the United States often also register with the CFTC, primarily because it is required if they intend to advise U.S. citizens or residents about contracts regulated by the CFTC.
Other major regulatory agencies include the U.K's Financial Services Authority or FSA, the Australian Securities & Investments Commission or ASIC and the Swiss Federal Department of Finance or Swiss PolyReg.
In addition, local European agencies operating in their respective countries under the European Union's MiFID or Markets in Financial Instruments Directive are also generally sound. Basically, having your forex broker's activities overseen by at least one major regulatory agency certainly cannot hurt.
Although the forex market is unregulated, many forex brokers that deal in other products such as futures will often register with a regulating agency to maintain a clean reputation and to attract more clients.
Therefore, to avoid any of the numerous potential forex frauds and scams, only opening a trading account with an appropriately regulated and well capitalized online retail forex broker makes a lot of sense.
Finding the Best Forex Broker
Finding the best forex broker really depends on each trader's individual needs when trading the forex market. Knowing what to look for in the broker is really the responsibility of the trader. Getting a good broker before beginning to trade can make a big difference to a trader's bottom line, so do research in advance and choose your broker wisely. Read our extensive article on how to approach the task of choosing your forex broker here.
For the next article in our article series - Go Next >> Dealing spreads provide incentives >>
A deeper description of questionable forex broker practices.
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.