26 Nov 2019
Things to Look for in a Forex Broker
Trading in the largest financial market in terms of market cap comes with its own share of gains and risks. The latter becomes more pronounced if the right trading infrastructure and money management tactics are not available. Such challenges become magnified without access to and support from a competent and licensed forex broker. For an aspiring trader, it is important to select a good broker, not only to maximise trading results over the long term, but also to protect their funds from misappropriation. A number of factors need to be considered before you start trading with a forex broker, such as personal profit goals, flexibility and technological feasibility. Here are some important factors to take into account while choosing a forex broker.
Fund Safety and Regulatory ComplianceThere have been plenty of cases where traders have been duped by their broker or have lost money due to a sudden bankruptcy. This makes it vital to check whether the broker is regulated in the region where they operate. Over the years, the financial regulatory authorities around the world have become very stringent regarding guidelines for brokers, especially keeping the protection of clients in mind. These bodies keep a close watch on brokerages and come down strongly on any firm that fails to comply with the guidelines. Forex broker regulations, however, differ from country to country, which is why many reputed brokers have multiple licenses from various regulating agencies. This offers traders greater confidence to entrust their funds with the firm. Some of the most sought after licenses are the UK Financial Conduct Authority (FCA), US Securities and Exchange Commission (SEC), European Securities and Markets Authority (ESMA) and the Cyprus Securities and Exchange Commission (CySEC). They all have separate guidelines and prerogatives to issue broker licenses, as well as laws to protect investor interests. Some basic protection clauses to look out for are:
- Segregation of client funds in separate accounts from that of the broker, maintained with reputed banks
- Negative balance protection
- Standardised risk warnings regarding risky financial assets
- Leverage limits. For instance, the ESMA prescribes a leverage limit of 30:1 for major currencies and 2:1 for cryptocurrencies. The United States imposes a 50:1 leverage limit on major currency pairs.
- Easy access and withdrawal of funds
- Safe transactions
- Regular P/L and order statements for clients. The company’s financial statements also need to be audited at prescribed intervals.
Trade Execution ModelBroadly, there are two kinds of brokers: Dealing Desks (DD) and Non-Dealing Desks (NDD), which also include hybrids.
1. Dealing Desk Brokers/ Market MakersThese brokers set the bid/ask spread on their own terms and systems, and usually take the opposite side of the client’s trades. They make money through spreads and by offering liquidity.
2. Non-Dealing Desk BrokersThere are again three main sub-categories here:
- STP (Straight through Processing): All orders are routed to the broker’s liquidity providers, including banks, hedge funds and big investment firms, which occupy the counter positions in each trade. These providers set the bid/ask rate and the broker acts as a silent bridge between the liquidity provider and the trader. Some brokers also provide Direct Market Access (DMA), where orders are filled at the best available price, with a small mark-up spread.
- ECN (Electronic Communications Network): Real-time order book information, where spreads are based on quotes from a large network of liquidity providers. Mini communication networks allow trades to be executed at lightning speed with minimal slippage. Spreads offered are much tighter.
- STP+ECN Hybrid: Many brokers offer a blend of the ECN and STP model, to fully automate the process of order entry, spread pricing and trade execution.