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About Forex Brokers
Forex brokers are our gateway to the global Interbank foreign exchange market. Whenever you want to trade a particular foreign currency pair, you are buying one currency in exchange for another. Forex brokers either buy or sell you the currency or they direct your order to their liquidity providers, who then match your order with other willing parties.
Basically, Forex brokers facilitate access to the market by providing a platform to both retail and institutional traders.
Besides providing a centralized trading platform and access to markets, Forex brokers also provide their clients with margin trading facility. Hence, with the power of broker provided leverage, retail Forex traders can trade much larger sums. Without this ability to use high leverage, which often starts from 100:1 and can be as high as 500:1, the Forex market may not have been so attractive.
Besides Forex, there are very few markets where you can deposit a mere $1,000 into your brokerage account and trade as much as $100,000 or even $500,000 worth of foreign currency and get to keep any profits.
Technically, when you go to a foreign country and exchange your home country's currency to buy some travel cash in the destination country from a foreign exchange dealer at the airport, it is also part of the global Forex market. However, the difference between such a small-scale dealer and your Forex broker is how the law distinguishes these two entities.
Why Strict Regulation is a Key Factor in the Forex Brokerage Industry?
You see, providing access to the global Forex market is a privilege in most jurisdictions. Because unlike your local foreign currency dealer, Forex brokers act as custodians of large sums of capital deposited by their clients who come from all walks of life.
There have been a lot of unfortunate incidents in the past when even reputed brokers with thousands of clients suddenly vanished off the face of the earth and embezzled millions of Dollars. Even in well-regulated markets like in the United States, there were several high-profile scandals. In one instance, an Iowa-based US Forex Broker called Peregrine Financial Group (PFG) was investigated for embezzling $200 million of customer funds!
Even today, if you search for Scam Brokers, you will find hundreds of brokers operate from small Island nations with more or less bucket shop business models. Therefore, Governments in major financial hubs around the world control the Forex brokerage market through their financial regulatory authorities. If you are looking to sign-up with a Forex broker, make sure that the broker in question is licensed to conduct brokerage business in its respective country and is preferably regulated.
While the level of fraud in the industry went down significantly over the last decade, you should still remain very vigilant and it is best to stick with brokers who are regulated in a major developed country. Since the introduction of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, a lot of major Forex brokers in the USA moved their operations abroad, where regulatory measures are more business-friendly. In light of the strict regulatory requirements and trading restictions enforced by the CFTC in the USA and despite the fact that as a result not many international forex brokers offer services to US citizens, there are still a few that do. A list of some of these can be viewed here: Brokers For US Traders
Over the last decade, major financial hubs like Sydney, London, Singapore, and a number of other cities have attracted Forex brokers. In fact, as a direct consequence of the Dodd-Frank act, a lot of best Forex brokers have shifted their business to Australia and the United Kingdom and decided to be regulated by the Australian Securities and Investments Commission (ASIC) and the Financial Conduct Authority (FCA). Check here for a list of brokers regulated by ASIC and here for a list of brokers regulated by FCA.
Hence, most of the brokers we list and review are not based in the United States, despite New York and San Francisco being two of the major financial hubs in the world.
How the Spot Forex Market Works
The global foreign exchange market is a decentralized market. Unlike stock exchanges, there is no central authority facilitating the trades. The prices we see on sophisticated charts are just representing transactions between two willing parties at any given point in time. As a result, different Forex brokers often show different levels of liquidity in their Level II window. In fact, sometimes you will find completely different price quotes at different brokers. The divergence is often so large that savvy traders make a profit out of it by arbitrage.
Before you endeavor to pick a Forex broker, you need to know and familiarise yourself with how this decentralized spot market works. Because unless you are well-versed with the intricacies of the spot Forex market, you will not fully grasp the different business models brokerage firms employ to turn a profit.
What Are Some Common Types of Forex Brokers?
If you are new to the Forex market, you might wonder that what difference does it make to your trading if your broker has a different business model compared to another broker in the industry. As long as you get to buy and sell your desired currencies, who cares?
Once you realize how your broker executes your trades and who the actual counterpart to your transactions is, you will finally grasp the true extent of why it is so important.
Let's take a look at some of the common types of brokerage businesses out there and how they operate trading facilities for their clients.
In a traditional sense, market makers were large banks or financial institutions that matched the orders from their clients to create ample liquidity. Without market makers, there would not be enough liquidity in the market and traders would experience large gaps and price swings.
When it comes to Forex trading, market makers could be your own broker, who acts as the immediate counterpart to their clients. Since these brokers are actively trading against you, buying when you are selling and vice-versa, there might be some conflict of interest.
Market maker Forex brokers make their money by charging traders the spread (gap between the buy and sell price). They are constantly buying and selling the same currency pairs, in both directions, to thousands of their clients. So, if you get a recommendation to buy or sell a particular currency pair, there could be a possibility that your broker is trying to balance their books and that's when the conflict of interest arises. Hence, if you know that your broker does not pass your orders to third-party market makers, but acts as a source of in-house liquidity, make sure that you take any trading advice from their research department with a pinch of salt.
Electronic Communication Network (ECN)
Unlike market makers, Electronic Communication Network (ECN) brokers pass on your orders to third-party buyers and sellers. However, keep in mind that a standard lot in the spot Forex market is worth $100,000 and most retail traders execute mini or even micro contracts.
So, an ECN broker will try to consolidate a large number of orders into a single order and pass it to its liquidity providers, the true market makers, and other market participants. Since ECN brokers consolidate orders, they usually trade with substantial volumes. Consequently, the economics of scale enable them to get preferential rates in the Interbank market. As ECN brokers can pass on these savings to their clients, trading with an ECN broker usually means paying much lower fees and commissions compared to trading with a Forex broker that acts as a market maker.
Therefore, if you have to choose between a market maker and an ECN broker, it is recommended that you prefer the ECN broker unless the market maker has offered a substantial discount on spreads to you as a private brokerage client.
Straight Through Processing (STP)
As the name suggests, Straight Through Processing (STP) brokers pass their clients' orders directly to their pool of liquidity providers. You might be wondering, then, what is the difference between an ECN broker and an STP broker?
Well, there is a big difference in how the orders are routed and the fee structure of these two types of Forex brokers.
ECN brokers act more like a hub and try to disseminate orders from the liquidity providers to its internal clients. ECN brokers also charge commissions for each trade their clients make as well as negligible spread. On the other hand, STP brokers pass their client orders directly to the interbank liquidity providers and, usually, they do not charge any commissions. The key difference between ECN and STP brokers you need to understand is that the STP brokers connect each individual transaction with each liquidity provider they have in their pool.
However, compared to ECN brokers, the spreads charged by STP brokers are typically higher.
Also, keep in mind that STP brokers can often offer faster orders fails because they let their liquidity providers bid for the clients' pending orders. By doing so, STP brokers can quote Ask price from one liquidity provider and at the same time, quote Bid price from another liquidity provider. Doing so makes the STP model extremely competitive compared to the ECN model. Also, with variable spreads, traders usually get better quotes compared to brokers with different models.
Bucket shops are basically scam operations and once you know how they scam Forex traders; you will forever want to stay away from them regardless of how much bonus they are offering for you to sign-up with them.
Basically, a bucket shop does not even have any liquidity provider in the backend. They never pass clients' orders to the interbank market! They try to match buy and sell orders in-house by accumulating in their balance sheet. When you place a buy order with a bucket shop, the broker sells you the currency and it hopes that there will be enough sell orders from other clients to match so that it does not have a large exposure.
Bucket shops are betting that your analysis would be wrong, and your trade will turn out to be a loser. Since the majority of the newbie traders often lose, bucket shops have figured out a way to make a profit off these types of clients. However, if you are an experienced trader who is consistently being profitable and you are trading with a bucket shop, you will soon likely start to experience some difficulty trading.
In fact, there have been cases that if you are making money from trading, most bucket shops will start to arbitrarily increase spreads or even manipulate price feeds to take out clients' stop orders! Since any profit the client has made comes directly from the broker's own pocket, there is a direct conflict of interest and most Government regulators do not allow bucket shop models to operate under their jurisdiction.
We said most because there are a lot of shady jurisdictions in smaller Island nations that really have no manpower to provide the level of checks-and-balances to catch a broker involved in scamming customers by being a bucket shop. We simply endeavor to not list or review such brokers when we identify them!
Factors to Consider When Choosing a Forex Broker
If you are picking out a new broker, pay attention to the following things to keep your hard-earned capital safe. Moreover, if you do your homework about the broker that you are about to invest your funds with, there is a good chance that you will compare its fee structure with other industry-leading brokers and come to a rational conclusion about your decision.
Here are some of the top things you should consider before signing up with a Forex broker:
As we mentioned before, regulatory oversight is one of the most important factors in picking a broker. Here are some of the top authorities from around the world and their respective legislative jurisdiction that you should check before signing up with a broker that claims to be regulated by that country.
|Australian Securities and Investments Commission (ASIC)
|The Bundesanstalt fur Finanzdienstleistungsaufsicht (BaFIN)
|The United States
|Commodities and Futures Trading Commission (CFTC)
|Cyprus Securities and Exchange Commission (CySec)
|The United Kingdom
|Financial Conduct Authority (FCA)
|Swiss Financial Market Supervisory Authority (FINMA)
|Please check our home page for a detailed list of Regulatory Authorities
There are many more brokers operating in smaller economies like Malta and Seychelles. However, the regulatory oversight in those places may not be as strong.
Security of Client's Funds / Segregated accounts
Some regulators make it mandatory for Forex brokers to keep their clients' funds in a separate account. By not allowing client funds to be mixed with the company's operational funds, regulators protect clients from any financial trouble such as bankruptcy. If you are trading large sums of capital, try to stick to brokers who will keep your funds in a segregated account.
Business Model of the Broker
As we discussed earlier, how a broker collects and passes your orders to the interbank market makes a lot of difference. Hence, when picking a Forex broker, you should always prefer ECN and STP brokers compared to market makers. It goes without saying that you should always avoid a bucket shop regardless of how lucrative their fee structure is or how well-marketed the company appears.
Transaction Costs and Fees
If you are a swing trader, spreads and commission fees are less important. However, if you are a short-term day trader and make ten trades a day, fees and transaction costs will soon add up. Depending on what type of trader you are, pay close attention to the fee structure of the broker you are about to sign-up with.
Ease of Deposit and Withdrawals
Nothing is more frustrating than sending a wire transfer to your Forex broker and seeing long delays in crediting your account. One of the key benefits of faster deposit and withdrawal is you do not need to keep large sums of money in your account.
If you have a $5,000 trading capital and you want to risk only 2% on each trade, you can simply keep $500 in your trading account and still risk $100 per trade and you will have ample capital to execute five trades!
But, without a prompt deposit facility, this strategy will not work, and you will need to keep a substantial amount in your account all times.
After regulatory oversight, the trading platform is perhaps the second most important factor. The platform is where you conduct your daily business. Without the right charting tools and technical indicators, it would be nearly impossible to implement any sound strategy. So, test the software platform of the broker before investing with them.
How fast your broker fills your orders will make or break your success as a Forex broker. Especially, you should test the broker during major news releases to see how fast your orders are getting filled. Also, ask customer support about where their actual trading servers are located to see if Internet latency would be reasonable. A broker might offer the best features, but if their server is located on the other side of the world from you, life will be unnecessarily difficult when it comes to placing orders with that broker.
The customer support department of your broker is your point of contact. If anything goes wrong, and it will eventually if you stay in this business long enough, you need to know that you can depend on the broker's customer service to resolve the issue. If you sent a large deposit and there is a delay, will someone talk to you on the phone and help you resolve the issue? What about if your Internet is gone and you need to close an important order, can you just call support to help you with such matter even if they do not offer order placement via phone?
It is wise to double-check on these things with smaller deposits before investing large amounts with any Forex broker.
Leverage and Margin
Leverage is one of the most attractive features offered by Forex brokers. While US Forex Brokers cannot offer more than 50:1 leverage due to the Dodd-Frank Wall Street Reform and Consumer Protection Act, brokers operating in other parts of the world should at least offer a 100:1 leverage.
Moreover, read the fine print of the broker to see what the margin requirement for the currency pairs you often trade. The relatively higher margin requirement is usually a bad thing and can lead to unnecessary margin calls if you like to open multiple orders at the same time.
Initial Deposit Amount
If you are a new Forex trader, you would ideally want to invest a small sum to get your foot in the door. Having a large initial deposit requirement will put too much stress on you as a trader from a psychological perspective.
Try to look for Forex brokers that offer at least Mini accounts, if not Micro accounts. With Mini and Micro accounts, you can test the broker's platform and the trading environment without risking too much in the beginning. Hence, it gives you the option to open a Standard account or Pro Account later.
Type of Assets Offered
If you trade only a handful of Major Forex pairs, then most brokers will suit your needs. However, if you want to diversify your Forex trading portfolio and look for trading opportunities with a wide range of minor and exotic currency pairs then you should pay close attention to the offered assets.
Moreover, a lot of Forex brokers now offer Contract for Differences (CFDs) for major Indices and Stocks. Also, you can trade a range of emerging asset classes like Cryptocurrencies with some Forex brokers. If diversification is one of your key goals, pick a broker that offers such assets for trading.
The global currency market is a very competitive place. Having the right broker by your side to access it will help you become a successful trader in the long run. We have spent a considerable amount of time and energy to review and rank some of the best Forex brokers from around the world. However, keep in mind that there is no BEST Forex broker out there, only a broker that is best suited for your needs.
With that note, while searching through our extensive list of forex brokers, compare various aspects of a Forex broker that we have reviewed and consider signing up with the broker that you believe offers the services you need!