How To Choose A Forex Broker

There is a great deal of fraud in the forex market, so it would behoove the new forex investor to check out the broker thoroughly. One of the best ways to do so is to check if the broker is registered by the National Futures Association (NFA). Because the forex market is largely unregulated, forex brokers do not have to be members of the NFA, but they can register if they want to. If they are members of the NFA, then the firm can be checked out by using NFA’s Background Affiliation Status Information Center (BASIC). Here you can find out about the firm, its main principals, and about any regulatory actions against the firm and their resolutions. It is highly recommended that you do not do any business with any broker who is not a member of the NFA. Otherwise, it would be difficult to check the background of the broker, and little you could do if the broker turned out to be less than honest. Other good ways of checking a broker is by talking to other forex traders through the many forums dedicated to foreign exchange.

Forex Fraud Information from the Commodity Futures Trading Commission (CFTC)

The Commodity Futures Trading Commission (CFTC) has witnessed increasing numbers, and a growing complexity, of financial investment opportunities in recent years, including a sharp rise in foreign currency (forex) trading scams. A federal law enacted in December 2000, called the Commodity Futures Modernization Act of 2000 (CFMA), makes clear that the Commission has the jurisdiction and authority to investigate and take legal action to close down a wide assortment of unregulated firms offering or selling foreign currency futures and options contracts to the general public. In addition, the CFTC has jurisdiction to investigate and prosecute foreign currency fraud occurring in its registered firms and their affiliates.

In light of the CFMA, the CFTC has issued an Advisory concerning the offering and trading of foreign currency futures and options contracts involving the retail public, and also revised and re-issued its 1998 Consumer Alert on foreign currency trading to help the retail public identify foreign currency trading scams. The CFTC’s Advisory reaffirms that off-exchange trading of foreign currency futures and options contracts with retail customers by a counterparty that is not a regulated financial entity as set forth in the CFMA is unlawful.

In its separate Consumer Alert, the CFTC warns consumers of sales solicitations appearing in newspapers, radio or television promotions, or attractive Internet websites, touting high-return, low-risk investment opportunities in foreign currency trading, and of highly paid currency-trading employment opportunities. The CFTC urges the public to be skeptical of such claims and suggests some "red flags" to look for, and cautionary steps to take, before trading foreign currency products.

Division of Trading and Markets Advisory Concerning Foreign Currency Trading By Retail Customers - March 2002
Advisory on Foreign Currency - February 5, 2001
Consumer Advisory: Beware of Foreign Currency Trading Frauds
Consumer Advisory Brochure on Forex Fraud
Questionnaire Form - to report information to the CFTC regarding forex (or other commodity futures or options) activities

In addition to these Forex Advisories, the CFTC has also issued several other Consumer Advisories that are posted on the Customer Protection page.

Broker Registration and Background Information

Before you open an account, you should always check on the company's or individual's status:

Background Affiliation Status Information Center (BASIC)
Through this online system, National Futures Association (NFA) makes available registration information and futures-related actions contributed by NFA, the CFTC and the U.S. futures exchanges. If you need registration information that's not available in BASIC, you can contact NFA's Information Center at (800) 621-3570.

Administrative Sanctions in Effect List
This list contains the names of firms and individuals that currently have registrations and trading sanctions in effect as a result of administrative and statutory disqualification proceedings.

Reparations Sanctions in Effect Lists
These lists contain the names of individuals or firms who have not paid awards which were levied against them as a result of reparations proceedings.

Proceedings Bulletin
This bulletin contains information about the Commission's administrative and injunctive enforcement actions and its statutory disqualification-from-registration proceedings.

Security of Funds

The funds of most forex brokers are not guaranteed, nor are they segregated from the funds of the firm. If the firm goes bankrupt, you will probably be just a general creditor, and may not get all, or any, of your money back. No government organization guarantees the funds, unlike the funds in a bank account or a stock brokerage account.

Currently, the CFTC requires that a forex firm have a minimum of $1,000,000 of capital, and $5,000,000 if it trades options.

Financial Data for Futures Commission Merchants

Futures commission merchants (FCMs) must file monthly financial reports with the CFTC's Division of Clearing and Intermediary Oversight within 17 business days after the end of the month. Selected financial information from these reports is published here: http://www.cftc.gov/marketreports/financialdataforfcms/index.htm.

The most recent month-end information generally is added within 12 business days after FCMs file their reports, but occasionally may be added later. Once posted, the CFTC does not revise this information to reflect any amended financial information subsequently received.

Trading

After finding reputable brokers, you need to gather more information about how they do business, are they readily available to answer questions, or resolve complaints. You can do this by reading what they have on their website, and by calling them on the telephone to see how quickly and how well they respond, or getting advice from the many chat rooms about forex, including those provided by the broker. Although almost all forex trading is done over the Internet nowadays, sometimes Internet connections don’t work, or the company’s trading platform isn’t working the way it should or the way you think it should, so it is very important that they also provide telephone service.

Most brokers offer both regular and mini-accounts, and require trades in specific lot sizes. A regular account usually requires at least a $10,000 deposit, and lot sizes are 100k—that’s 100,000 units of currency—and leverage ratios up to 100:1. With a ratio of 100, it takes only $1,000 to buy or sell $100,000 worth of currency. A pip is equal to 10 units of currency with 100k lot sizes. If the currency is USD, then 1 pip = $10.

Mini-accounts require a deposit of as little as $100, and lot sizes are usually 10k, with leverage ratios as high as 200—$100 can buy or sell $20,000 worth of currency. A pip = 1 unit of currency. If the currency is USD, then 1 pip = $1. You can generally buy or sell as many lots as you have leverage for, so a mini-account allows smaller increments. For instance, with a mini-account, you could buy or sell $30,000 worth of currency, but with a regular account, the minimum would be 100,000 units of currency, or increments of 100,000 units.

Managed funds are accounts in which the broker does the trading for the investor for a fee.

Many brokers, especially those with international offices, also have accounts for other currencies for traders in other countries.

The most important criteria in selecting a forex broker after assuring yourself that they are reputable brokers is the trading platform, the currency pairs offered, and the spread, the difference between the bid/ask prices, which is how the forex broker is compensated, and the best way to judge these criteria is to open practice accounts with several brokers, which most offer, and trade for about a month in each account.

Practice accounts allow you to trade forex using live market data and using the company’s software, but without using actual money. It is important to practice with such an account, because forex transactions can be confusing, and using the software will take some learning, especially to use the software proficiently.

Practice accounts are a good way to test your ability to actually enter transactions, and that you understand them. If the software doesn’t allow you to do something, this may indicate that you do not understand something correctly. Or it could be a bug in the software. Either way, you must determine what the problem is before you risk real money.

If you are going to begin trading with a mini-account, which is highly recommended, then you should also start with a practice mini-account. This will give you a better idea of actual profits and losses, both from trades and from interest.

Support

Telephone Support

While most currency trades are done over the Internet using the broker’s trading platform, it is important that they also provide telephone support, because if anything goes wrong with your computer connection or your computer, you won’t have any other way to initiate trades, set limit or stop-loss orders, or close out a position, which can lead to large losses over an extended period of time.

Support Chat

Chat is useful if you have a problem. It has more immediacy than email, but is usually easier than the telephone. Many problems, especially with the trading platform, require interaction, and chat provides the best method for resolving these kind of problems, since you can chat while actually using the trading software.

Supplementary Services

Many brokers provide other services to supplement trading activities. These include chat rooms, news, and charting services. While these are nice to have, there is no reason to restrict the use of these services to your broker's, since there are many other websites that also provide these services, and it is likely that there are some websites that will be better than your broker’s.

Forums

Forums, or chat rooms, allow you to talk about anything with other people. Forums are a good way to find out about other people’s experience with brokers, especially if you’re not using the broker’s forum. It is also a good way to learn about the trading platforms of various brokers, and about potential bugs. If you want to find out more about the trading platform that you are using, then it makes sense to talk to others in the broker’s forum, since these people are using the same software that you are.

However, do not take anyone’s advice on what trades to make. Use any suggestions as a different view and as a way to consider what you may not have considered otherwise, but most advice about trades is probably not good advice, because the currency markets are very random. Few people, probably not any, know what the currency markets are going to do in the next moment or the next day, and such advice, even if it turned out to be correct, would become rapidly stale in the fast random walk of currency prices.

Charts

Charts are helpful in seeing where currency pairs have been. All currencies trade within a certain range. As one currency trades higher against another, corrective forces start to limit the ascension. For instance, if the dollar is weak against the Euro, then more United States products will be sold in Europe, because they will be cheaper and fewer European products will sell in the United States because they will be more expensive. This increases demand for the dollar and lessens it for the Euro. Likewise, more Europeans will be inclined to tour the United States because their money is worth more, and fewer Americans will be inclined to travel to Europe because it will be more expensive.

Charts are also used extensively in technical analysis, which tries to predict future prices by seeing patterns in the charts. While many traders use technical analysis for trading, because it is very difficult, if not impossible, to predict currency prices from fundamental considerations, forecasts based on technical analysis are frequently wrong, and long-term forecasts could not possibly have any validity because ultimately, it is the relation of supply to demand that determines prices, and technical analyses cannot quantify this, nor predict changes in fundamental variables, such as the future interest rates of countries.

News

News can sometimes be a big mover of markets, and it is widely available. The problem with news is that it can be too much, and it can be hard to forecast prices based on the news, since many factors affect currency prices.

Most trading platforms have squawk boxes that deliver the news as it comes out. Most of this information is difficult to read and harder to interpret. Often it is based on someone’s technical analysis of current charts, but if one could make money simply by following the advice of technical analysts, then we could all be rich.

Conclusion

You must remember that when you place an order with the broker, your order cannot be seen by anyone else other than your broker—not even other brokers. All of your transactions are with the broker—not other traders. This is the big disadvantage in trading over the counter (OTC), in contrast to organized exchanges. The OTC market is great if you have a need to hedge some transaction in business, for instance, and you need specific terms, but it is not really that good for trading for profit, because it is the broker that decides what the spread is, and it is the broker that buys and sells with you. So a good part of your potential for profits is whether your broker is fair. In fact, because the broker develops the trading software, or, at least customizes it, you can be restricted from doing certain things that you might be accustomed to doing with stocks, for instance. You may not be able to set a limit order within the current spread to initiate a trade, for instance.

One factor you should definitely consider is requotes. A requote occurs when you thought you made a purchase or sale at one quote, but the broker tells you that it was actually something else, usually at a less favorable price to you and more favorable to him. If you get more than a few requotes, you should definitely consider taking your business elsewhere, because it shows a lack of integrity for the broker.

A good way to compare actual trading is to open real mini-accounts with several brokers. Because mini-accounts require very small deposits to open, most people should have no problem opening several accounts to see what their actual profits and losses are, broker fees, and responsiveness. This also helps if one of the brokers goes bankrupt. At least you won’t lose all of your money because you placed it with one broker.

How to Choose a Forex Broker