The market for foreign exchange brokers is highly competitive, so narrowing down one broker to work with could be an undertaking. Each individual service provider offers its own unique features and advantages, and it is important to keep this in mind. While some strengths can be quantified rather easily—such as the broker's regulators and its financial strength—other benefits may be more difficult to evaluate.
Having such a diverse array of options may feel a bit overwhelming, but there are some questions you can use while narrowing down the competition. This article will provide further detail that can better prepare you for evaluating any forex brokers.
Before you start investigating potential vendors, it can be helpful to have a strong idea of exactly what you are looking for. By doing your homework beforehand and getting a sense of which attributes are desirable, you can potentially enjoy a more effective evaluation process.
How Stable Is Your Company?
If you want to evaluate a forex broker, asking how stable it is may be a great place to start. Before doing so, it could prove beneficial to have a sense of exactly what information you are looking for. Here are some factors to consider when gauging the stability of a forex broker:
Company Background: How long has the company been in business? Has it weathered many economic downturns?
Financial Strength: How much cash does the broker have available? What amount of regulatory capital does it have set aside to meet requirements? How much surplus regulatory capital does the firm have? Who audits the company's financials?
Client Base: How large is the broker's client base? If a company has a large number of clients, it likely has a better chance of remaining solvent than a firm with fewer clients.
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Are You Regulated?
Another way to assess a forex broker is to ask whether it is regulated. If it is, the company will likely provide detail on the exact regulators it is registered with. In the U.S., the National Futures Association, a self-regulatory organisation, as well as the U.S. Commodity Futures Trading Commission, an independent agency, have jurisdiction over forex brokers.
If forex brokers do business in countries other than the U.S., they may register with regulators in those jurisdictions. For example, brokers that offer forex trades in the U.K. generally register with the Financial Conduct Authority.
It is worth noting that if a forex broker does business in multiple countries, it may be registered with several regulators. Different countries take varying approaches to regulating the financial services industry; for some, regulation is compulsory. As a result, they may have distinct registration requirements.
By understanding a forex broker's regulatory status in addition to how the appropriate regulators govern, traders have the opportunity to manage risk more effectively.
Where Do You Get Your Pricing? Who Executes The Order?
Forex brokers can use a few different methods to obtain pricing:
Dealing Desk Execution: Under this structure, the forex broker is responsible for both creating the pricing and executing the orders. When using this method, the spreads, or difference between the bid and ask prices, are generally fixed and could be higher than variable spreads. Dealing desk execution may come along with restrictions, so it could prove beneficial to ask about any such limitations.
No Dealing Desk Execution: In this model, market makers stream bid and ask prices to traders through forex broker platforms. The market makers then execute these orders for investors. Under this setup, traders generally face none of the restrictions they would when using dealing desk execution.
Are There Any Trading Restrictions?
The trading restrictions an investor will face when working with a forex broker depend on several different variables. For starters, some regulatory agencies have provided restrictions that affect all brokers within their given jurisdictions.
Anti-Hedging Restriction: The NFA enacted Rule 2-43(b) in 2009, which obligates multiple positions involving the same currency to be offset in a first-in, first-out basis.
Here is the exact text of Rule 2-43(b):
"Forex Dealer Members may not carry offsetting positions in a customer account but must offset them on a first-in, first-out basis. At the customer's request, an FDM may offset same-size transactions even if there are older transactions of a different size but must offset the transaction against the oldest transaction of that size."
Leverage Restrictions: Investors looking to harness leverage when trading forex could face restrictions. The amount of leverage a trader can use when working with a specific broker will be based on many variables, including the broker's size, where the investor wants to do business and the regulations in that jurisdiction.
Additional Restrictions: Traders may face restrictions provided by their brokers. For example, the broker may impose limits on orders based on the type of execution. Investors can benefit greatly from asking potential forex brokers to outline these matters.
What Are Your Trading Costs? Are There Commissions Or Markups?
Before you ask brokers to explain their trading expenses, it can be beneficial to obtain a better sense of what your trading model will look like. How frequently do you plan on making transactions? How much principal do you want to place in your account?
Additionally, working with a broker that has good relationships with banks and is well-capitalised can result in lower trading expenses.
Spreads: Brokers may provide both fixed and variable spreads, and there are pros and cons associated with each. Some traders may opt to work with fixed spreads because of the certainty, while others may choose to engage in transactions involving a variable spread in hopes of paying less.
For example, if EUR/USD is trading for 1.0952 - 1.0955, the spread is three pips. If the broker has fixed spreads, then the spread will always be three pips. Should the broker harness variable spreads, then the spread could range between less than one pip and several pips.
When market conditions are volatile or lack liquidity, brokers may apply slippage, which means they charge more pips than the average spread. For investors looking to make short-term trades or take positions based on the latest news, slippage could be problematic.
As a result, traders may benefit from asking brokers how they handle situations that could result in slippage.
Markups: Some brokers add markups, which are charges over and above the market spread. Markups reduce transparency but trading costs are simpler to calculate when compared to commissions-based accounts.
Commissions: Some brokers generate revenue by charging commission, which is a fee levied for each transaction. This model can prove beneficial for traders, as it can provide them with transparency into exactly what they will pay every time they make a transaction. There are different types of commission, including fixed fee and relative fee.
Under a fixed-fee agreement, the broker will charge traders the same amount regardless of the trade's volume. Alternatively, a service provider that charges a relative fee will calculate the commission based on the total volume traded.
Additional Fees: In certain cases, brokers may charge inactivity fees, margin costs, monthly or quarterly minimums, or fees associated with speaking to a broker over the phone. Also, trades held overnight can create an expense called rollover, which is based on the underlying interest rates of the two currencies.
Armed with answers to these questions, you should be able to find the broker that best meets your trading needs.
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