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Main » Articles » Forex for Beginners

How to Choose a Forex Broker - 2

Choosing a good forex broker is one of the most important decisions you need to make at the beginning (or at any point) of your forex trading career. Do not take this decision lightly, but at the same time don’t stress over it – the process does not need to be complicated – just like in your trading decisions, once you do your homework, things tend to fall into place. Chance favors the prepared trader and everything you need to make an informed decision is listed right here. All you have to do is follow the advice given and you will find yourself a broker that suits your needs. If you are not familiar with what is available, you can have a look at the brokers we have listed in our Broker Reviews section to familiarize yourself with who is who in the forex world. If you have already narrowed down your search to just a few, or even one broker, and want to be sure that they are in fact what you want, then keep reading.

Regulation (the "Legitimacy Test")

The first thing you need to do is check whether the broker is regulated. The fact that the forex market itself is not regulated opens the door to a lot of possibilities for a scheming mind. There are shifty brokers out there, ranging from outright scams to just badly run businesses which are not accountable to any regulatory body. The brokers who are regulated choose to be so, in order to add a layer of legitimacy to their reputation. Please do NOT fund any accounts with an unregulated forex broker. There are not many good reason to do so, and plenty of reasons not to. It just makes sense.

By far the most respected regulatory bodies are the US-based National Futures Association (NFA) and Commodity Futures Trading Commission (CFTC). Most forex brokers, even if they are not based in the United States, are members of the NFA and registered Futures Commission Merchants (FCMs) with the CFTC. The UK based Financial Services Authority (FSA) is also a well respected regulating body, as is CySEC (Cyprus), ARIF (Switzerland), ASIC (Australia) and SFC (Hong Kong) among others. Just because a firm writes on their website that they are regulated however, does not make it so. Always check the websites of the regulating bodies themselves – they all offer a searchable database that allows visitors to find regulated members by name:
NFA/CFTC: http://www.nfa.futures.org/basicnet/
FSA: http://www.fsa.gov.uk/register/home.do
ARIF: http://www.arif.ch/en/membres.htm
CySEC: http://www.cysec.gov.cy/licence_members_1_en.aspx
ASIC: http://www.search.asic.gov.au/gns001.html
SFC: http://www.sfc.hk/sfcprd/eng/pr/html/PR002.jsp?charset=ISO8859_1

It is also important, particularly for US-based forex brokers, to be well capitalized. Well capitalized companies tend to be much more stable and less prone to insolvency. This is particularly true in the US because brokers here are not required to keep client funds segregated from company operating capital, so clients are at increased risk in case of insolvency. For CFTC registered FCMs, you can look up the broker’s operating capital:
http://www.cftc.gov/marketreports/financialdataforfcms/index.htm

Furthermore, if the broker does keep client funds segregated, it is certainly a bonus, since it provides additional protection of client funds even in case of insolvency. FSA regulated brokers, for example, are required to keep client funds segregated. This of course begs the question, where are the funds being kept? Are they in a safe account at a large bank or some dodgy private bank in the Cayman Islands? You can find answers to these questions in our broker reviews section. Alternately, the broker’s customer support should be able to answer these questions. If they cannot, they may be hiding something (or the customer service rep may simply be incompetent - either way it's not a good sign).

Timeframes

OK, so your broker has passed the “legitimacy test”. They are regulated, well capitalized, and they don’t mix client funds with operating capital. Now it’s time to make sure that they provide the type of trading conditions that suit your trading style. Depending the timeframes that you trade, it may be important for spreads/commissions to be very low. Also, if you trade very short timeframes (scalping) you should make sure that your broker doesn't have a problem with that. Generally, brokers who are market makers will have a problem with it, while brokers that use straight-through processing or actual ECNs generally don't mind. Please read our "ECNs vs. Market Makers" article if you are not sure what that means. If you are a day trader, then your transaction costs can make you or break you. If you enter and exit the market several times per day, these costs really add up. Consider, for example, that you are trading 1 mini lot (10,000), 5 trades per day on EUR/USD. If the spread your broker offers you is 3 pips on average, then you are paying $3 per trade, $15 per day, $300 per month etc… you get the picture. If you instead had a broker that offers you an average spread of 1 pip on EUR/USD, then you would be paying $1 per trade, $5 per day, $100 per month! That’s a difference that anyone serious about their business should not ignore.

On the other hand, if you are a position trader, who makes 5 trades per year, then the difference amounts to only $10 per year. This is minimal and may very well be outweighed by other factors, such as perhaps higher overnight interest rates in a carry trade strategy, or better customer support or some other factor that gives you more than $10 of value added with the higher spread broker. So neither broker is better or worse, they are just better suited to different styles of trading.

Automated vs. Discretionary Trading Styles

Some broker platforms are also better suited to automated trading. For example, MetaTrader 4 (MT4) is a favorite among retail traders who program their own “Expert Advisors” or “EAs”. If that’s you, then this could be a determining factor when choosing a broker. On the other hand, if you are a discretionary trader who bases trading decisions on a combined technical and fundamental analysis approach, then it may not matter to you whether the broker offers MT4 or not, as long as the platform offers you good charting. You can visit our broker reviews page for details on which brokers use which specific trading platforms.

Islamic Swap-Free Accounts

Another factor could be a broker’s choice to offer Islamic accounts, which do not charge or pay any rollover or swap interest. Traders bound by Sharia Law are not allowed to conduct any business dealing with interest, so some brokers may be off your list as a result. Many brokers offer swap-free accounts, but many also do not. Moreover, some brokers that do offer swap-free accounts may do so only under certain conditions (read extra fees), since such accounts are susceptible to abuse, and brokers are very much aware of that.

It should also be noted that the brokers who do offer swap-free accounts to all their traders, with no extra charges, are a great choice for non-Islamic traders as well, if they simply want to short the carry trade - just be careful, as most such brokers are not regulated.

Tradable Instruments

Finally, when it comes to trading style, some forex brokers have a much wider range of tradable instruments than others. In addition to the major currency pairs, some brokers allow you to trade exotic pairs (such as PLN/SGD or Polish Zloty vs. Singapore Dollar) Gold, Silver, Oil or any number of other instruments. You may or may not find these of interest, but if you do, then going with a broker where you can trade your desired instruments is a must.

Minimum deal sizes

Another concern, particularly for smaller accounts, is minimum deal sizes. Some brokers only allow you to trade standard lots (100,000), which does not give someone with a $5,000 account very much flexibility when it comes to money management. Money management is a very important aspect of any trading strategy, and the finer “resolution” you can get when calculating deal sizes, the more accurately your money management calculations can be reflected in reality. This is an often overlooked or at least underestimated factor when it comes to choosing a broker, but it is absolutely critical. The best choice for small account holders are the brokers that offer traders deal sizes as small as 1 unit, giving traders maximum flexibility when choosing the size of their trades and positions.

Leverage

In contrast, an often overestimated factor involved in the appropriate choice of a broker is maximum leverage allowed by the broker. Most forex brokers have a margin requirement of 1% or even lower, which allows for 100:1 maximum leverage – more than enough for any sensible trader, and yet some traders insist on ridiculous 0.25% margin requirements. This has been the highway to ruin for most who have tried to use anywhere near that much leverage. You don’t have to be a genius to see why, since leverage multiplies your drawdowns. All it takes is a small losing streak and your account is blown. In any case, this is not a lecture on the pitfalls of high leverage. We can address that in another article. Suffice it to say that low margin requirements and the resulting high maximum leverage should NOT be a factor when choosing your forex broker.

Customer Support

One way to get a glimpse inside your forex broker’s business is to contact their support staff by a variety of methods. Send emails, use live chat, call them, get them to call you, whatever. No matter how small or irrelevant your questions may seem, they are important. Not only because you are a potential customer and you deserve their time and attention, but also because it allows you to judge how committed they will be if you do open a real account with them. If they are unable or unwilling to spend time with you to answer your questions now, then they most likely won’t act any differently after they have received your money. I encourage you to ask as many questions as you can think of, sometimes even ones you know the answers to, just to see if they will lose patience with you or refuse to answer questions that may seem obvious, or that expose their weaknesses. Some brokers get defensive when you ask them about regulation, for example – not a good sign. Make sure you also ask some tough questions about their internal systems, such as how they process orders, if they offset client orders in a higher tier or if they are the counterparty to clients’ trades, ask them about their liquidity providers, withdrawal fees etc (if you are not sure what these things mean, please refer to our "How Forex Brokers Work" article). These are all things that a client has the right to know. Any decent broker has to respect that and give you the answers. There is no reason not to, unless they have something to hide. It is also a good idea to keep a record of all your correspondence with your broker, just in case some disagreement arises in the future.

Test-run the Platform

All forex brokers nowadays offer traders the ability to test their trading platform with a demo account. Before funding a real account, it is highly recommended that you do this. It will give you an idea of how the platform performs. Are there any glitches? Is it stable? Is it fast? Is it easy to use? Is the charting package any good? Does it have the features I need? These are all questions you can answer very quickly when trading on a demo account. What you cannot know from trading a demo account, unfortunately, is how order execution will be on a real account. Execution is always flawless on demo, but this is not representative of the real market and can be vastly different if/when you make the switch to real market conditions. It is also not possible to withdraw the money from a demo account (very unfortunate), so you cannot judge how quickly these are normally processed. The same goes for deposits. The best way to get an idea of this is to have a look at our broker reviews page, where we have tested each broker with a real money account, and given them a 0-5 rating on how good their order execution is, how quick their transaction processing is, and a number of other important facts.

How we can help

We built a broker review section that is specifically designed with the above criteria (and more) in mind. We have listed all the information you could possibly want to know about each broker in order to help you choose the right broker for your individual needs. This is the most detailed information you will find anywhere, because we have thoroughly tested each broker with real money accounts. We keep adding new broker listings all the time, so check back every once in a while. We hope you find it useful.



http://www.forextradingzone.org/articles-How_to_Choose_a_Forex_Broker

Category: Forex for Beginners | Added by: forex-market (2009-05-06)
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