A broker in the general sense is someone who acts as a go-between for a buyer and a seller. In forex the idea is the same: some people or organizations want to buy a certain currency and others have such a currency for sale, so the forex broker will typically buy from the seller, increase the price by a certain percentage, and then re-sell at that new price to the buyer. Like brokers in general, they exist for different reasons; they provide an entry point to the world of forex for the millions of traders in the world and they provide additional services for the buyer, the seller or both.
Brokers make their living in a large part from the difference in the price paid by the buyer for a currency and the price paid to the seller. This is the “spread” that is expressed in “pips” and explains why brokers would like spreads to be bigger (to make more profit), but traders would like them to be smaller (less cost to trading). The market then determines the size of the spread that will be a reasonable compromise for both parties.
Within the overall category of forex brokers, different types of brokers exist. Whether or not a particular type is the best forex broker depends on the way you want to trade. The two major types of forex brokers are the market makers (retail forex brokers) and the Electronics Communications Network (ECN) brokers. The market makers as their name suggests make their own market in the different foreign currencies. They will offer buying and selling prices to traders, but can also change these prices according to the amount of currency they themselves have bought or sold, and the overall trends in the forex market. Like bookmakers at horse races, their goal is to adjust the money they pay out according to the money they bring in so as to bring in more than they pay out.
ECN brokers on the other hand rely on a group of contacts linked in an electronic network. Traders’ requests to buy or to sell are matched with the best available offers to sell or buy, respectively. The ECN brokers charge a commission for this service, but the spread is determined by what the buying and selling traders agree between themselves.
Forex brokers can also offer different ranges of services to help traders make better deals with less effort. Services often cost money to produce and run, so forex brokers may provide them as part of higher cost “premium” service. Whether or not you choose to use such a premium service will likely be determined by how experienced and confident you are in forex trading. Traders who are prepared to do their own forex market research for example may see less value in news services offered by forex brokers, and prefer to use a broker who provides less, but who also charges less. On the other hand, novices may prefer to choose a broker with good technical support, and even training.
Within the two main categories above there are then several sub-categories. Some forex brokers offer specific trading interfaces such as the Metatrader system, while others make trading accounts available for traders to trade on behalf of others (such as the PAMM accounts). These facilities may or may not affect the cost of trading. The Metatrader system is provided free to brokers anyway, and PAMM accounts are in the broker’s interest because they lead to greater quantities of currency being traded and therefore to greater profit for the broker. Further categories of brokers are also defined by their affiliation (or not) with different regulatory bodies such as the NFA or the FSA, which give some indication of the quality and integrity of the broker concerned.
What makes forex brokers different from each other?
What makes one forex broker different from another does not necessarily make it better – or worse. Forex is a competitive one for brokers as well as traders and there is considerable scope for brokers to try to differentiate themselves in their efforts to stand out from the others and thus attract more trading funds that then make them more profit.
Let’s start with two factors that often have considerable mindshare among traders and that brokers use to try to market themselves more effectively – spread and leverage. The natural reflex is to go for the lowest spread possible between the buy and sell prices for a currency. In theory, this is the right thing to do because each trade is then automatically that much closer to profitability (although this of course does not stop deals from making losses). On the other hand, many brokers make a significant part of their money from the spread and if spreads are too small to allow brokers to provide any additional services such as support or trading advice, then beginners may be off to a rocky trading start indeed.
When forex brokers offer lower spreads, the attraction is lower trading costs. When they offer increased leverage, the “attraction” is the possibility to multiply trading profits by trading with money that isn’t yours. Unfortunately this is only one half of the story. Profits can be multiplied, but so can losses. The nature of leverage is that if a trade goes against you, you can wipe out your trading account before you know what happened. 400 to 1 leverage may make a broker “different”, but it’s a difference that most experienced traders would prefer to be without.
For other items that differentiate brokers, it is the trader who has to decide for himself or herself whether such differences are important. Common sense plays a large part here. Just like figuring out which bank you’ll do business with, or even which job offer you’ll take or which house you’ll buy, start with a checklist of what’s important for you. Whether you make this list all by yourself or you put it together by reading up on different sources and offers is less important, than having it available before you analyze the pros and cons of a specific broker.
For example, when you’ve already made your trading plan, based on how you want to trade, the amount of risk you want to accept and related factors, you’ll be in a much better position to know which differences between forex brokers will be important for you and which will be at most just a distraction. For example, if your plan says that you will stick to the most commonly traded pairs of currencies like EUR/USD or USD/JPY, then a broker offering 23 different currency pairs is offering a difference that has no value to you. If on the other hand, your plan says you will engage in very short-term trades, then a forex broker that explicitly states that it accepts scalping may be offering a difference worth y of your attention.
Finally, differences between forex brokers can also often be evaluated in terms of comments from traders. If a particular feature of a forex broker made them money, then they may well speak about it. If a feature lost them money, then they probably will speak about it. Trader appreciation of broker differences may be a useful a guide as any brochure or specification from the brokers themselves. And given that the best forex brokers will share similarities and not necessarily differences, in the first instance traders may be better advised to concentrate on looking for a broker with a strong reputation and track record first of all, and only look for the differences after that.
Why is it important to select a good forex broker?
Although it’s tempting to dismiss brokers as a necessary evil in order to be able to trade forex and just head for the lowest spread, a little reflection and selection can pay dividends. Yes, brokers are the gateway to the forex market, but the quality of that gateway can have a dramatic effect on your trading and the profits or losses that you make. The question is then: What is a “good forex broker”? Factors affecting the quality of a forex broker can be divided into two kinds. One group contains the factors that help you to avoid problems. The other group is oriented towards elements that work to positively improve your profitability.
A broker being registered with an entity such as the NFA (National Futures Association) for example helps traders using that broker to avoid problems, because of the financial solidity required of the broker by the NFA. However, the fact that a broker has sufficient funds to avoid financial catastrophes of its own is no guarantee that your trades will be successful. Likewise, brokers that offer lower minimum lot size will allow traders to reduce trading risk and use a selection of micro or mini lots in different currencies, rather than being obliged to “put all their eggs in one basket” and buy bigger lots of currency.
Depending on how you look at it, fast order execution can either help you to avoid losses or help you to improve profits. Whatever your point of view, it’s an important criterion and contributes to a particular broker being considered as good or not. Slippage (changes in the final price of a trade because of slow order execution) is the enemy of trading profit, and anything that negatively impacts profit is by definition not good. The ability to execute an order in less than a second in any market should be the norm for any broker.
So what about the rest of the factors that lead towards profit rather than simply helping to prevent loss? The trading interface and technical tools offered can make a difference here. Access to a platform online for example that is sophisticated enough to accept stop-loss orders as well as buy and sell orders can make a big difference to profits. Among other things, it allows you to implement trading strategies that incorporate probabilities of losses, to limit them with stop-loss orders and to globally generate trading profit.
Technical tools that you know how to use and that you favor can likewise positively impact your profit. With the wide range of trading techniques and indicators now available, the best results are sometimes obtained by just using a handful of tools that fit your trading style and that continue to give you good results. If candlestick charts speak volumes, but Bollinger bands mean nothing special to you, a “good” forex broker for you is likely to be one that offers you those charts in an easy-to-use and effective format.
Should you select a “good forex broker” on those attributes alone? The answer will depend on what is important for you personally as a trader and which broker best fits your trading strategy. However, it’s worth mentioning another factor, double-edged this time – leverage. Good forex brokers will make it possible for you to adjust your leverage as you require, whether this is done by calling your broker or online. Depending on how you want to trade in any particular period, you may want to adjust leverage up or down to favor either increased profits (but watch out for losses as well) or decreased risk. A broker that does not lock you in to a certain leverage, but allows you to change this already scores merit points.
What types of forex brokers exist?
As far as forex brokers go, there are the good, the bad and the ugly. While you would normally want to focus on the ones that are good, it’s worth noting some of the characteristics of the bad, so that you’ll know what you need to avoid. And the ugly? Read on to see what we have to say about them too.
“Good” is a relative concept. What’s good for another forex trader may not be so good for you and vice versa. How to choose a forex broker is the subject of another article in this series, so for this one we’ll simply describe different types of broker as follows.
Brokers in the forex market can in general be “market makers” or dealers. Market makers take positions themselves by buying different currency pairs at one price and offering them to traders at another price, or selling them at one price and offering to buy at another price – in forex, you can always trade, whatever the market is doing. In theory, as long as market makers make a profit in either buying or selling like this, then they do not particularly care if you make a profit or not. In other words, they are not for you or against you. They are neutral. Dealer brokers on the other hand simply act as the intermediary between you and the other party. They have no particular investment to worry about. They make their money by charging a commission on any trade they facilitate. This is the case of ECN (Electronic Communications Network) brokers, who use a network to get a buying order from one trader filled by a selling trader elsewhere, and vice versa.
One group of forex brokers offers specific trading platforms for trading, such as the Metatrader platform. Traders who want to use this platform can then choose between different brokers of this type, comparing each one on criteria such as services offered, spread and so on. Another type of broker offers managed accounts, so that investors can appoint a trader to make trades with the money in their account and on their behalf.
Although there are many good, reputable and conscientious forex brokers to choose from, the currency trading market is like other markets – it too has its villains. Some so-called “brokers” simply operate scams. They promise you the earth, take your money and then disappear. It can be an expensive lesson in checking out forex brokers before handing over your investment capital. Other brokers operate in what are called “bucket shops”, using a variety of techniques including betting directly against the investor without even opening a position in the forex market. It’s not real forex brokering and novice traders in particular would do well to stick to the “safe” options in previous paragraphs.
Which leaves us with the ugly… This is our way of describing brokers or forex brokering practices which are dubious to say the least. Sniping (or hunting) is one example: the broker prematurely executes a buy or sell order near to, but not at a pre-defined point in order to make more money (so you make less). Changeable rules about how much leverage a broker gives are another example. By redefining the rules whenever they want, brokers could for example close a trader’s position when it was losing, but while the trader still had enough margin to work with and before the position recovered to make the trader a profit. Experience with a particular broker will indicate whether or not this happens. Better still; check out acquaintances and online forums for news of any such incidents, or for information about better forex brokers to do business with.
How to choose your forex broker
The best way to choose your forex broker is not by visiting as many broker’s websites as possible. It’s not by asking all your friends and acquaintances “who’s the best?” It’s by first of all deciding how you want to trade in forex, by defining your trading strategy and your trading plan, and then looking for brokers who meet your requirements for executing on your plan. What happens if you do it the other way round? Anything could happen. You might be lucky and select a broker that turns out to be the right fit for you, makes some successful trades and then manage to parlay this into a workable plan. However the chances of all this happening are about the same as having snow fall in summer -not impossible, but very unlikely.
Successful forex trading is largely based on first having a good system and then sticking to it. Your forex broker is the channel by which you access the forex market and put your plan into action. So yes, you need to choose a good broker for the forex trading you want to do. But let your plan determine your broker – don’t let your broker determine your plan.
You may have several choices of broker possible, each of which meets your requirements. If they can each be a suitable channel to let you trade successfully on the forex market, then you can calculate a score for each of them based on the different factors involved, roll dice for it or go with your gut feeling. If you’ve done your homework and figured out your strategy, then in this situation you’ll end up with a suitable broker in any case.
Your trading plan should have filtered out or perhaps instead narrowed your choice to certain types of broker. If you want to use a particular platform (MT4, MT5 or whatever) or particular technical tools (pivot points, Parabolic SAR, MACD…), then you’ll need or prefer a forex broker who offers these as part of the package. Depending on your trading plan and the resources you can reasonably make available, certain brokers whose minimum requirement for opening an account is too high will naturally drop off your list.
Therefore, you’ve already filtered out a number of brokers and/or narrowed your search down to the others. What’s left? For one thing, you have a plan and you want to stick to it, so it would be wise to choose a broker who has clear rules of engagement that will also help you stick to your plan. Policy on leverage is a case in point. First of all your trading plan should specify how you will use leverage (sparingly!). Many forex brokers offer leverage to relatively high levels, so obtaining the maximum level of leverage you want according to your plan should not be a problem.
However, you then need to make sure that your forex broker “channel” will behave in the right way when you trade, meaning that when you agree a level of leverage, the broker will not then arbitrarily change that level in the middle of your trades. Some brokers do this for positions that are showing losses, even though at the agreed level of leverage, the trader still has available margin to continue the trade. You’ll need to find out if that is the case, and take that broker off your list and look for another.
What’s left? When you’ve examined the other strategic points, there’s always the spread and if all other things are equal, the forex broker with the lowest spread is the best choice. But make sure that you’ve checked and compared all the factors important to you before using price as a final decision factor.
10 Questions to ask your forex broker
When you want to use a forex broker, you may well have many more than just 10 questions on your mind. But in order to start somewhere, here’s a selection of some questions that are commonly asked. Brokers may provide answers to some or all of them on a website or in a brochure. Make a list of the questions you want to ask (including the ones below, for example) and put the ones most important to you at the top. Then fill in the information you get about one broker in a column next to the list of questions, the info about another broker in another column next to that and so on. That way, you should easily be able to compare offers and how well they meet your requirements.
Ready? Then let’s get started.
1. What are your forex broker’s qualifications for offering a forex broker service? Look for registration of the broker with organizations like the NFA and the CFTC for the US, the FSA for the UK or similar entities in other countries. The number of years of experience in the forex market and any discussion about the broker in online forums are also worth noting.
2. What kind of forex trading do they offer? Some brokers may standardize on the Metatrader platform for example. Others may offer managed accounts, where other traders manage your transactions for you.
3. What is the minimum deposit for opening an account with the broker? Bigger or smaller is not necessarily better or worse. See how the minimum amount affects you and your finances first of all. Some brokers may simply be out of range.
4. What charges are there (if any) for keeping an account open? Depending on the level of service you want, charges may apply (for example, if you have a forex account that is managed for you).
5. How efficient is their customer service? Whatever they offer, it should be rapid and effective. But remember that levels of service offered (and any charges that go with them) can vary from one forex broker to another.
6. Another question to ask your forex broker: which currency pairs are offered for trading? You don’t necessarily need everything under the sun, but you do need the currency pairs that you want to trade in.
7. What are the costs per transaction? This is often a matter of the spread (difference between buying and selling a currency) that the forex broker is offering. As such, it’s a number, it’s easy to compare and smaller spreads are better for you, but remember this is just one factor out of several.
8. How quickly are orders executed? Faster is better, so that the price you see when you pass an order is the price (or very, very close) at which your deal is really done. It’s difficult to find any justification for slower speeds of execution. Forex markets can move very quickly and the risk of a good deal turning into a bad one is too high.
9. What analytical tools and information are supplied to help you trade better and do you have to pay for them? Yes, you can find out a lot by yourself, but it’s also worth having relevant information immediately available when you’re trading, so that you can see trends and make reasoned trading decisions.
10. What other costs might you incur? If the span of your trading periods is greater than a trading day, then for deals that you have open overnight, say, forex brokers may charge interest. Find out beforehand what their policy is so that you can take account of this in your trading strategy.
What makes the best forex broker?
The best forex broker is the one that works best for you. There are certain characteristics that every good forex broker needs to display, such as honesty, integrity and a reliable, easy to use trading platform with good performance. A broker can offer you the most mouthwatering combinations of currencies, leverage and technical tools you can think of – unfortunately, they won’t do you any good if your trades never make it to profitability. On the other hand, the best broker for you then also needs to the one that offers you the best combination of spread, lot size, minimum deposit size and so on. Let’s have a look at both sides of the equation: what no good broker in forex can do without; and what will then determine your choice as a function of the kind of trading you want to do.
Honesty sounds like a given – would you really contemplate doing business with a broker that you knew to be dishonest? It’s likely that many forex brokers are honest, for the simple reason that dishonesty in any trade rapidly attracts bad publicity and leads to loss of customers. However, that’s no reason for you to lose money because a broker turns out to be less than truthful about the broking services offered. Possibilities for safeguarding against this include preferring brokers who are registered with regulating bodies such as the NFA or the FSA, and making preliminary checks on the Internet and in online forums to see if a broker is mentioned for any reason.
A forex broker with integrity can still be out to make money (after all, they have to make a living too), but will guard against practices or actions that could unduly compromise your trading. Leverage is an example. Ramping up the possibility of leverage (the amount of money you can “borrow” to make bigger trades) to ratios like 400 to 1 may sound enticing. However, when this is twenty times more than many experienced traders would use, it would be a lack of integrity for a broker to push this as distinguishing feature of the service offered, especially to novice brokers. Scalping/slippage (very short term trading and delays in filling orders, respectively) are similar. If a forex broker says scalping is possible, but does not qualify any possibilities of slippage appropriately, there may not be any false information, but because effective scalping requires zero or near-zero slippage, it is a lack of integrity not to give appropriate information for both items.
This brings us to the broker’s trading platform – its performance, reliability and ease of use. However it works, online or over the phone, it needs to be fast enough to correctly support the kind of trading you want to do. Your orders to buy or to sell have to be filled at the price you see then and there and not later when the price has changed. It needs to be reliable – when you give an order, the order is executed and not lost in the system. And it needs to be easy enough for you to use. How easy is easy? It all depends. If you don’t want to have to handle the detail, you might look for a forex broker offering managed accounts, where you can have a trader make the day to day decisions for you. If you’re passionately interested in how forex trading works, you’ll find other more technical interfaces easy to use if you have the motivation to understand and profit from them.
After that, it’s a question of money – what it costs you to trade and what profit you can make. Using demo accounts with different forex brokers to simulate what would happen in terms of profits or losses is often a good way to find out more about the best forex broker for you.