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Choosing a FOREX Broker

Types of FOREX Broker

DD — Dealing Desk — FOREX brokers that operate (route orders) through the Dealing Desk and quote fixed spreads. A dealing desk broker makes money via spreads and by trading against its clients. A Dealing Desk FOREX broker is called a Market Maker - they literally "make the market" for traders: when traders want to sell, they buy from them, when traders want to buy, they sell to them, so they will always take the opposite side of the trade and in this way "create the market". A trader doesn't see the real market quotes, which allows Dealing Desk brokers (Market Makers) manipulate with their quotes where they need to in order to fill clients orders.

NDD — No Dealing Desk — NDD FOREX brokers provide access to the Interbank market without passing orders trough the dealing desk. With true No Dealing Desk brokers there are no re-quotes on orders and no additional pausing during order confirmation. This, in particular, allows trading during news times with no restrictions on trading. An NDD broker can either charge commission for trading or choose to increase the spread and make FOREX trading commission free. No Dealing Desk brokers are either STP or ECN+STP.

STP — Straight Through Processing — STP FOREX brokers send orders directly from clients to the liquidity providers - banks or other brokers. Some STP brokers have just one liquidity provider, other several. The more there are liquidity providers and therefore liquidity in the system, the better the fills for the clients. The fact that traders have access to the real-time market quotes and can execute trades immediately without dealer intervention is what makes the platform STP.

ECN — Electronic Communications Network — ECN FOREX brokers additionally allow clients' orders to interact with other clients' orders. ECN FOREX broker provides a marketplace where all its participants (banks, market makers and individual traders) trade against each other by sending competing bids and offers into the system. Participants interact inside the system and get the best offers for their trades available at that time. All trading orders are matched between counter parties in real time. A small trading fee - commission - is always applied. Sometimes STP brokers are discussed as if they were ECN brokers. To be a true ECN, a broker must display the Depth of the Market (DOM) in a data window, let clients show their own order size in the system and allow other clients to hit those orders. With ECN broker traders can see where the liquidity is and execute trades.


Broker revenues: fixed vs variable spreads vs commission

ECN FOREX brokers always have variable spreads. Only ECN brokers charge commission for trading FOREX. Commission is the only revenue/profit an ECN broker receives. ECN brokers are not making money on bid/ask (spread) difference.

An STP FOREX broker is compensated through the spread (spread markups). STP brokers have a choice of offering variable or fixed spreads. STP brokers route all trading orders to the liquidity providers - banks. These brokers, as intermediaries between their clients and banks, receive prices (spreads) posted by the banks on the Interbank market. Most banks, in fact, offer fixed spreads and are market makers.

An STP broker therefore has 2 options:
1. Let spreads be fixed.
2. Leave the spread at 0 and let the system take the best bid and ask from the number of banks (the more the better) and in this way provide variable spreads.

How an STP broker earns its money? Since STP brokers (as well as ECN) don't trade against their clients, they add own small markups to the spread quote. This is done by adding a pip (or half a pip, or any other amount) to the best bid and subtracting a pip at the best ask of its liquidity provider. All client orders are directly routed to the liquidity providers at original spread quoted by those providers while an STP broker earns its money from own markups.

Many STP brokers run a hybrid STP model: DD + NDD
When an STP broker offers microlot trading (as a practice account for newbies), such small volumes are not accepted by its liquidity providers and are handled in a dealing desk system. For all larger orders (as a rule, above 0.1 lot), the STP broker uses its real STP technology and sends orders to its liquidity provides. With each transaction, the broker receives a portion of the spread.

FOREX market maker - a broker with a dealing desk earns money on bid/ask difference as well as when a client loses a trade, since they are the counter-party of the trade.


ECN brokers are the purest breed among all FOREX dealers. They don't profit on spread difference. Their only profit comes from commission. ECN brokers are interested in their clients to be winning, otherwise there will be no commission to earn.

STP brokers make money on spreads, thus even though they do not have a physical dealing desk to monitor and counter-trade client orders (unless its a hybrid STP model), they are still able to set their own price - the spread markup - for routing trading orders to liquidity providers and providing their clients with advanced trading services, lower account deposits, faster execution and anonymous trading environment with no dealing desk. STP brokers are also interested to see their clients trading profitable, so that a broker can continue earning on spreads.

Market makers make money on spreads and by trading against their clients. However, if a client becomes "too" profitable, it can directly "upset" the broker. While this may be tolerated and professionally managed by a larger reputable market maker, with a smaller dealer such client will be soon asked to leave.


Trading Parameters

Trading Costs

Trading costs (spread markup or commission) can have substantial impact on the profitability of a trading strategy, particularly in daytrading and scalping. It is therefore important that the broker charges as low trading fees as possible. On the other hand, extremely low fees may indicate a scammer running a fraudulent system with no trading costs at his side. To be charged reasonably low trading fees and trade with a trustworthy broker at the same time it is highly advisable to look for brokers that deal directly with large commercial banks without any intermediaries. Such brokers typically disclose their liquidity providers on their website (or are willing to disclose them on request). Also, be always aware if you are going to sign a deal directly with the broker without any third party involved or if there is a middleman (so called "introducing broker" or "referring broker"). In the latter case you will be charged extra (but hidden) fees from every trade you make to reward the middleman.

Maximum Leverage

The maximum leverage being offered by FOREX brokers varies from 20:1 up to 1000:1. Leverage 100:1 is more than sufficient for any trading with responsible money management. If you fully used 1000:1 leverage for opening a position, it would mean 9 lots of volume per each 1000 USD of account balance. In consequence each 1-pip move of the market against the position would consume 90 USD per each 1000 USD (in case of USD as the quote currency) of the free margin. Combined with no margin call policy the whole account could be lost within a couple of minutes (11-pip loss and it's all gone). This is ridiculous and when no negative account balance is not guaranteed by the broker it can become a nightmare. Brokers offering extreme leverage do so not to provide you an advantage, but to rob you of all your money as fast as possible.

Margin Call Policy

There are substantial differences in margin call settings of individual brokers. In the most reasonable case, the lossy position is closed when there is only the blocked margin left and no free margin in the account. Some brokers let the position consume up to e.g. 50% of the margin deposit (after no free margin remains in the account). There are even brokers that let the lossy position consume all the free and blocked margin and continue into negative account balance (i.e. there is no margin call applied). Such brokers are likely scammers turning the trader's loss into their own profit.


Broker Regulation

Deposit money only with brokers whose operation is controlled by a national regulatory body. These agencies were made to protect the public against fraud, manipulation, and abusive trade practices. In the U.S. it is CTFC and NFA.

Commodities Futures Trade Commission (CFTC)

This agency was developed in 1974 to protect individuals in futures and commodities trading. Since futures include the currency market, the CFTC protects FOREX traders as well. From 1974 to the present, the CFTC has undergone many changes in hopes of improving trading conditions and creating a level playing field for everyone. Five commissioners appointed by the President, the offices of the Chairman, and the agency's operating units make up the Commission. The Commission has 3 offices along with HQ located in Washington, D.C. – Chicago, Kansas City, and New York. Futures exchanges are also located in these cities. The CFTC provides order in a market that would otherwise be chaotic. The mission of the CFTC is to protect market users and the public from fraud, manipulation, and abusive practices related to the sale of commodity and financial futures and options. In the "unregulated" FOREX market, this regulatory agency helps determine if a FOREX company is reliable or trustworthy.


The CFTC's Website can be found here:

http://www.cftc.gov/index.htm


National Futures Association (NFA)

The NFA is an industry-wide self-propelling organization created in 1982 that regulates the futures market in the United States. NFA's activities are overseen by the Commodity Futures Trading Commission (CFTC), the government agency responsible for regulating the U.S. futures industry. The NFA's mission is to ensure futures industry integrity, protect market participants, and enforce NFA members to meet their regulatory responsibilities. Virtually every firm or individual who conducts futures or options on futures business with the public must be registered with the CFTC and a Member of NFA. NFA performs the registration process on behalf of the CFTC. NFA Member categories include: Commodity Trading Advisors (CTA), Commodity Pool Operators (CPO), Futures Commission Merchants (FCM) and Introducing Brokers (IB). In order to conduct any business in the futures market, you would have to be a member of the NFA. To be a member of the NFA, an organization would have to pass a screening done by the NFA and comply with NFA standards and regulations. These rules and regulations provide market integrity and a level playing field for all, and not just for investors. Over time, they have been making significant progress. In order to resolve futures-related issues, the NFA began an arbitration method in 1983. In 1991, a mediation program was developed as a faster way to resolve disputes. In late 2001, the NFA started to accept claims online. Members could also start registering online in 2002. In 2004, the NFA started to submit digital images of fingerprint cards to the FBI enabling quicker background checks and shorter registration times. Along with the CFTC, the NFA provides investors and individuals with security and protection from fraud and scams.


According to the NFA Web site, there are about 2,000 retail forex brokerages and solicitors of accounts that are not subject to latest rules. Out of that 2,000, the NFA has only 27 registered member firms! You can verify CFTC registration and NFA membership status of a particular broker and check their disciplinary history by phoning NFA at (800) 621-3570 or by checking the broker/firm information section (BASIC) at the NFA's website


The NFA's website can be found at:

http://www.nfa.futures.org/index.asp


NFA's Forex Transactions Regulatory Guide:

forex-regulatory-guide.pdf


Following regulators oversee broker operation in the UK, Switzerland, and Australia, respectivelly:

UK: The FCA and PRA

TOn April 1, 2013, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) replaced the Financial Services Authority (FSA) as the financial industry's regulatory bodies in the UK. The Financial Conduct Authority is a non-government agency funded by the firms they regulate, and they are accountable to a Board appointed by the Treasury. Their goal is to protect consumers, ensure industry stability, and promote healthy competition in the financial services industry through the regulation of financial advisers, asset managers, or any firm not covered by the PRA.


FCA website:

http://www.fca.org.uk


The Prudential Regulation Authority is a part of the Bank of England, and their main role is to promote a healthy UK financial system through the regulation and supervision of banks, credit unions, major investment firms, and insurers.


PRA website:

http://www.bankofengland.co.uk/pra


Switzerland: FDF, FINMA, and ARIF

The Federal Department of Finance or FDF was formed in 1848. While the FDF is the overseer of financials in Switzerland, it is the Swiss Financial Market Supervisory Authority or FINMA that regulates the banks, securities dealers, and stock exchanges. Association Romande des intermediares financiers or ARIF is similar to FINMA, but this body is based on the French speaking part of Switzerland. ARIF was formed in 1999. It too acts as a regulatory agency with members abiding by certain rules and laws.


FDF website:

https://www.efd.admin.ch/efd/en/home.html


FINMA website:

http://www.finma.ch/e/Pages/default.aspx


ARIF website:

http://www.arif.ch/en/index.htm


Australian Securities and Investments Commission

Founded in 1991, the Australian Securities and Investments Commission (ASIC) acts as a corporate regulator in Australia. ASIC regulates companies, financial markets, and financial service organizations as well as insurance, and credit. The organization aims to maintain fairness in the market environment.


ASIC website:

http://www.asic.gov.au


Recommended Broker Summary

  • No dealing desk broker
  • Headquarted in a trustworthy location (e. g. London, New York)
  • Regulated by a national authority (explicitly stated)
  • Segregated client accounts
  • Liquidity providers disclosed (should be large banks)
  • Reasonable trading costs
  • Reasonable margin call policy
  • Guarantees no negative account balance
  • No introducing broker involved
  • Comfortable trading platform (check with a demo account)

Altogether, extreme caution is recommended as there are few really honest brokers and a lot of potential scammers around.


Signs You Have Chosen the Broker Well

  • Fast order execution (a fraction of a second)
  • Limit orders filled at the set price (except very rare extreme market conditions)
  • Average slippage close to zero
  • Trading costs match the expected values
  • Trading platform behaves the same with demo and real accounts
  • No price or spread spikes not seen in independent tick streams
  • No difficulties whith money withdrawals
  • Reliable customer service



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