How to choose a Forex Broker – What you Need to Know
In the early 1990’s trading actively on the Foreign Exchange was tricky.
Even if you had the means to, you still needed a lot of money to make entry level trades. The CFTC, a government regulator which was created to protect traders, started the ‘Commodity Exchange Act and the Commodity Futures Modernization Act’.
This new act created new opportunities for online Forex brokers to be created.
Brokers soon started popping up all over the world to take advantage of this new market. This fueled the retail trading industry into what it is today.
These days there are so many brokers to choose from, and so many different types.
The discussion of brokers can be overwhelming for new traders. New traders have now idea how to choose a Forex broker. So, in this chapter we will break them down into their basic categories, and discuss the pros and cons of each.
By the end of this chapter you will have a better idea on how to choose a Forex broker and who you can trust with your money.
Firstly, brokers will either have a ‘dealing desk’ or ‘no dealing desk’ arrangement.
You may have come across these terms when searching for brokers. All brokers will generally fall under one of these 2 main categories and will greatly impact how to choose a Forex broker that is suitable for your trading style.
Brokers with a dealing desk are classed as “market makers”. They make their money by adding a commission to the Ask price of the currency, creating the spread. Because they are a market maker, they literally create a market environment for their clients to trade on.
When a dealing desk broker receives a trade order from one of its clients, the broker will first try to match up with trade with another one of its own clients.
If successful, the broker has no risk associated with the trade and simply makes their commission from the spread, on both ends of the trade. It’s a nice little business model.
If matching up trades within their own clients is unsuccessful, they will take the opposite side of your trade by hedging it. Hedging will offset any losses that your trade may incur.
For example; if your trade is a loser, the profit from the hedge trade will cancel out the loss.
On the flip side, your trade is a winner and you make the broker some money – this is offset by the loss of the hedge position.
Advantages of Dealing Desk Brokers
The dealing desk will often have fixed more inflated, competitive spreads.
That’s the dealing desk broker’s only means of making profit from your trading activities – through the spread. Due to the high level of competition between the Forex brokers, the spreads are usually pretty cheap anyway.
Today spreads are so cheap, unless you’re into some high frequency trading, spreads are hardly noticed.
Fixed Spreads are generally alright for swing traders that hold positions for the longer term.
The spread cost is insignificant compared to the scope of their trades. But for scalpers and day traders – they generally like to find brokers with even more competitive spread pricing structures.
Disadvantages of the Dealing Desk
You don’t see the real market quotes
The dealing desk broker will only show you their quotes in your price feed, you don’t actually see the true interbank network quotes.
You only see what the broker wants you to see.
There is potential here for foul play on the broker’s behalf, with the ability to manipulate prices for selfish reasons.
“Stop hunting” is the term used when a broker manipulates prices so that your trade is prematurely stopped out. This sort of price manipulation is what unregulated brokers get away with.
When your trades are stopped out, it encourages traders to open more positions – because these unethical brokers know the psychology of their clients and their ‘need’ to always be in a trade.
Dealing desk brokers can see where all their clients stop losses are set. With this information, then they can manually alter the price feeds into their clients trading software with the intent to wipe out, or “trigger” all those stop losses.
This would be profitable for the broker because the trader would probably open another position and enter a Forex trade straight away.
Their business revolves around their client’s trade volume. Remember, these brokers make money each time you open up a position through the spreads (they create).
So they don’t care if your trade is a loser or a winner, because at the end of the day – they will be winners anyway. They would LOVE you if you sat there opening 50 trades a day.
Stop hunting usually only occurs with unregulated brokers. If a regulated broker participated in unethical practices like stop hunting – they WOULD be fined heavily and potentially lose their brokers license.
When signing up to dealing desk brokers, make sure they are regulated by a reputable government body. This protects you from fraudulent activity.
If the dealing desk can’t match up a trade, then you will receive a price re-quote on your trading screen – depending on their policy. Some brokers will absorb price re-quotes and still honor the original requested prices.
When a re-quote is passed on to you – your trading platform will give you the option to accept or decline.
It’s not uncommon to continuously receive price re-quotes during volatile trading times, as price is moving faster than the dealing desk can keep up. Eventually the re-quote frenzy will end, and your trade will most likely be filled at a worse price than you intended.
No Dealing Desk Brokers
No dealing desk brokers (NDD) have … no dealing desk; instead they act as a gateway, or a bridge that connects your trade to another party. Almost like how your internet service provider acts as a gateway to the rest of the internet.
No dealing desk brokers are split into 2 categories, the straight through processor (STP) and the electronic communications network broker (ECN).
The straight through processor
Non dealing desk STP brokers have a straight through processing system that has direct access to the interbank market via liquidity providers (the big banks).
The straight through processing system will find the cheapest ask quote available and the most expensive bid price available. Trading is all about buying low and selling high.
These won’t be the prices that you will see on your price feed though. The STP broker still needs to make some money too. They make their profits by adding some small spread commission onto the prices and then pass them onto you.
Advantages of an STP Broker
The non-dealing desk STP brokers offer cheaper spreads than a dealing desk, due to the fact they can always laser target the best prices from the interbank market.
Cheaper spreads can be an advantage to shorter term, and are highly sort after by traders who are into day trading and scalping strategies.
Disadvantages of an STP Broker
STP broker’s spreads are generally not fixed, like the guys that run a dealing desk.
Spreads fluctuate as the best available bid and ask prices as the interbank market quotes constantly change.
Most of the time the spreads vibrate around a constant level, but when the market experiences a flood of orders, ie when important economic news is released, the spreads can widen violently.
Spreads during the Non-Farm Payroll release can widen up to 10-20 pips easily.
If you like to trade during the news releases, then an STP broker with variable spreads is probably not for you, because your trades will be too expensive during the times you need to place them.
But you’re kind of putting a gun to your head trading in the heat of news releases. See our article: Trading the Forex News – Should You Be Doing it?
As exciting as the volatility may be – trading in the middle of news releases is not a smart way to trade.
The Electronic Communications Network Broker (ECN Broker)
The ECN broker acts as a direct gateway to the Electronic Communications Network, which connects you directly with other participants on the ECN.
Other participants who trades Forex including banks, large speculative companies like hedge funds and investment managers, large commercial companies and even the other brokers discussed in this chapter.
There are some brokers who claim to be true ECN brokers to gain the marketing edge, but in fact are just STP brokers.
Advantages of an ECN broker
The ECN broker passes the best bid and ask quote to you straight from interbank network with no manipulation to its price.
Because the ECN broker passes the interbank quotes straight to your trading platform, you only have to pay the spread difference between the best bid and ask price available at the time. In some cases the spread can be almost 0.
There is less lag in your trade execution time due to the fact that you are not trading with your broker. You are trading directly with the interbank network. You’ve essentially cut out the “middle man”.
Stable spreads during news and events.
Normally a broker’s spread will widen to the point that it’s way too expensive to trade during high volatility news releases and world events. With ECN brokers, what you see is what you get. This can be vital for news traders, as they can get in and out of trades without having to worry about widening spreads.
ECN brokers offer a feature called depth of market; this allows you to ‘view’ the liquidity of the market at different price quotes.
Disadvantages of an ECN broker
Since ECN brokers do not manipulate the spread prices that they are quoted, they need another means of generating profit. They do this by taking charging you a commission for opening the trade.
The commission cost is usually calculated by the volume of your trader order, or in other words per standard lot.
There are many options out there in terms of selection and how to choose a Forex broker. They all operate slightly differently in the handling of your trades.
How to choose a Forex broker really should depend on your Forex trading strategies, and your style of trading. These generally are the main factors in determining which of the best brokers will be best for you.
Just remember when selecting a broker, make sure they are regulated. Regulators protect you from brokers doing the wrong thing by you and believe me there are some horror stories going around about unregulated brokers.
I generally find brokers located in the United Kingdom, which are regulated by the FCA are the most reliable and the best performers.
Looking For A Reliable Broker You Can Trust?
If you are in need of a good performing broker I would like to take this chance to recommend the broker I’ve been using. As I mentioned I prefer the UK, or Austrlian regulated brokers – they are the most trustworthy, and generally have deep liquidity via good multi major bank access to the interbank market.
The broker I use is Go Markets Australia (because I am Australian). They are a straight through processing broker, with no dealing desk. So the spread pricing is going to be much cheaper.
Go Markets Australia are regulated by the ASIC, one of the most reputable regulating bodies in the world. This gives Go Markets a high level of trust and security.
There won’t be any stop hunting going on behind the scenes, and vantage absorb price re-quotes, so you will always get your requested trade prices – regardless if the market has experienced slippages between when you places your trades <-> to when the broker executes it.
My Discounted Spreads Deal with Go Markets UK
I actually have negotiated a deal with Go Markets UK and got a discounted spreads for anyone who signs up through The Forex Guy website. If you would like more information on this generous offer by my broker – you can find it here:
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