The foreign exchange market has no central marketplace, which requires investors to trade with a forex brokerage. The largest financial market in the world offers traders thousands of options when choosing a broker. In our guide we discuss the main concerns that any trader should be aware of before choosing to open an account and trade. To help you make an informed decision we have listed our recommended brokers here, which compare, brokerage types, trading platforms, trade details, help and support.
What should someone consider when choosing a broker?
1. What trading platforms does the broker offer? How reliable are they?
2. Is the firm a broker or dealer? What is the capitalization of the company?
3. Is the firm regulated? What license(s) do they have and from what countries were they issued?
4. Client support; is it available 24×5? By phone, chat and email? Is it reliable?
5. Commissions and fees; are there any additional costs a trader is required to pay?
6. What are the firm’s standards regarding leverage and margin calls?
7. Does the company offer any types of bonuses or promotions?
8. What types of trading accounts are available? Are accounts available for traders with varying; levels or skills, investment capital and trading preferences?
1. What trading platforms does the broker offer? How reliable are they?
Traders have different options when it comes to trading applications and hardware. Some traders choose to use web based applications while others might choose to use desktop software. It is important that traders understand their different options and choose which software application complements their trading preferences.
Reliability is one of the most important aspects of any trading platform. A trader should be able to place an order or close a trade instantly. It is essential that the platform does not frequently freeze or crash. Passive investors might not push a platform to its limits however aggressive traders; scalpers and intraday traders will. Breaking global news events are notorious for slowing down platforms, emphasizing the importance of using a platform with one-click operations allowing investors to trade and manage limits easily.
2. Is the firm a broker or dealer? What is the capitalization of the company?
Retail forex trading is offered by several types of companies; brokers, dealers and ECN brokerages. It is important to understand if the firm you are looking to trade with is a broker or dealer.
Trading with a Broker
The broker is an intermediary between the trader and the dealer or market maker. This model works by the client’s orders being processed without a dealing desk, also known as “NDD” or “Non Dealing Desk” by using computer software that allows orders to be sent to another organization that will execute the transactions at the dealing desk of a market maker. This process is called “STP” or “Straight Through Processing.” The spreads provided to the trader are reliant on the spreads provided at the dealing desk. Brokers are compensated by the market maker and/or fees they charge their clients for placing transactions.
Trading with a Dealer/Market Maker
Market makers work directly with global banks to continually preserve forex operations/positions and minimize overall risks regarding revenue and conversions. Every market maker has a “dealing desk;” this is the conventional method that the majority of financial institutions and banks use. Market makers provide two-way pricing to brokers and clients throughout the day. The pricing is quoted on two separate systems; “fixed” basis and “dynamic” spread. “Fixed” basis means that pricing does not move throughout the day while with the “dynamic” spread system, prices change as the liquidity in certain pairs change. Each market maker offers slightly different pricing for a specific currency pair and is compensated by their firm’s ability to manage their global forex risk. Compensation includes; revenue on swaps and conversions of residual profits or losses, spread revenue or netting revenue.
ECN (Electronic Communications Networks) Brokerage Model
In over-the-counter (OTC) forex, there is a modified broker model called the “Electronic Communications Network” or “ECN.” Instead of being the broker to one dealing desk, ECN acts as a broker for a number of dealing desks. Each dealing desk sends a price to the ECN and the amount of volume that a specific quote is “good” for, then the pricing is routed from the ECN to the trader. With the ECN system, the spreads are determined by the difference between the best bid and the best offer at a certain time. The ECN does not handle execution, just the communication of the order to the dealing desk from which the price was taken. The ECN is paid by fees charged to the customers in addition to a rebate (kick back) from the dealing desk based on the amount of volume that is given from the ECN. The ECN pricing and volume only shows what is available on a certain ECN, not the entire market.
Capitalization
The better capitalized the market makers are, the more credit relationships they are able to form with their liquidity providers equaling better pricing for themselves as well as their clients. The over-the-counter (OTC) market is very difficult for a broker to operate in without depositing a margin into a bank. Without the deposit, the broker will not be able to obtain competitive pricing. If a firm is regulated, there is a specific minimum capitalization level that must be maintained. The minimum capitalization level differs drastically depending on where the forex broker is regulated.
3. Is the firm regulated? What license(s) do they have and from what countries were they issued?
Forex regulation differs from country to country along with the financial registration requirements. Some countries have very lax regulations while other countries are very strict. Countries with strict regulations would include; European regulations (starting with Switzerland and Germany), United Kingdom, United States, Japan and Australia. It is important that traders are aware of the regulation requirements for the specific broker they are planning on registering and trading with.
4. Client support; is it available 24×5? By phone, chat and email? Is it reliable?
Forex is a 24 hour, 5 day a week, market, so it is important to have support available when you need it. Are you comfortable with the firm’s communication methods? If you like live chat or phone support, is this available? Is support available in your preferred language?
When you contact the brokerage, how knowledgeable are the representatives? Are you able to receive support for technical problems by phone? It is recommended to make a handful of “test” inquiries both online and by phone. This will give you a feel for how the brokerage operates their customer support.
Most forex brokerages have an in-depth online support section on their website in order to answer most questions without customer interaction however it is highly recommended to contact them prior to trading.
5. Commissions and fees; are there any additional costs a trader is required to pay?
Another difference between the forex and equities market is the commission and fee schedule. Market makers state that they do not charge any commissions or fees including; data fees, regulatory fees or exchange fees. In this scenario, market makers earn their compensation from spreads (difference between the buying and selling price).
There are three different commission formats used by forex firms; fixed spread, variable spread and percentage of the spread. Some forex brokerages offer traders the choice of either a fixed or variable spread. No matter what commission structure the trader chooses, the trader must be able to calculate all the (expected) fees to allow easy comparison with the other trading models. At this point, the trader will recognize their best option.
Market makers offer two-way pricing to traders throughout the day, these prices may be quoted on a fixed basis, meaning that they do not move throughout the day; however they might also use a dynamic spread system, meaning the prices change as the liquidity in certain pairs change.
A fixed spread means that the prices are established for the entire trading day and will not change within the day. Some traders might believe this spread is the correct choice since they will know exactly what to expect while on the contrary, they may feel they are receiving a good deal paying a variable but getting a smaller spread.
When a forex broker offers a variable spread, the trader can assume a spread that will range from 1-7 pips on most major currency pairs, depending on the degree of market volatility. When there is a lack of liquidity in the markets, it may push the broker to apply a “slippage” on the pricing. “Re-quote” or “slippage”, happens when your trade is executed away from the price you were offered and the trader pays more pips than the average spread. Possibly, this is a cost that you don’t want to encounter, especially if you are trading in the very short term or trade on news and global events. It is advisable to ask your broker how they manage global news events and methods they have in place to prevent slippage.
Lastly, certain brokers, like ECN brokers may charge an additional small commission, normally 2/10 of one pip. This is optimal for traders looking for very tight spreads since ECN brokers will send the orders to a large market makers group usually only available to larger investors.
What are the firm’s standards regarding leverage and margin calls?
Certain foreign exchange brokerages are recognized for offering a high level of leverage. Leverage is important and inviting to traders that follow aggressive trading strategies. These strategies are not for novices but for highly experienced traders. More conservative investors will not seek out high leverage brokerages but more moderate ones. Brokerages sometime offer fixed leverage while others have adjusted it to certain currencies.
High leverage does offer the possibility of large profits while also offering the possibility of large losses. Leverage is similar to a gun; it can be used for protection or when not handled correctly can shoot you in the foot. The difference is the training and knowledge of the user.
Margin call policies should always be understood. Some brokerage firms operate on FIFO (“first in, first out”) basis, while others operate on LIFO (“last in, first out”) basis. Others will simply close all the trades. When reviewing different brokerages be sure to review how they handle trades carried over the weekend.
Does the company offer any types of bonuses or promotions?
In the largest financial market in the world, you can imagine the competition there is to obtain new traders. Bonuses and promotions are important factors when a trader determines which brokerage they want to register and trade with. Our best forex broker list outlines our recommended firms offering not only bonuses but also attractive trading conditions.
Access to real-time news, economic data and charts are requirements for any trader. These tools are a value added service which some brokers provide to their clients. It should not be a deciding point to choose that brokerage but an added bonus.
What types of trading accounts are available? Are accounts available for traders with varying; levels or skills, investment capital and trading preferences?
There are three different types of trading accounts that are offered by most brokers. The accounts differ by the number of units that are being traded. A standard lot consists of 100,000 units, a mini lot is a tenth of the size consisting of 10,000 units and a micro lot is only 1,000 units. Certain forex brokerages will configure an account of an individual size for a specific trader. Accounts with small amounts of capital (smaller lots) are designed to be used by beginner traders. This allows new traders the ability to trade real money without the escalated risk of trading larger lots.
Review our recommended list of forex brokers for more information on choosing the right brokerage for you.
