Forex Brokers Merit Close Scrutiny

Forex brokers control your deposited money so it is important to understand what some have tried to get away with in the past so as not to fall victim to outright scam or unethical practices.

An official of the National Futures Association was quoted as saying, "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically...".

Between 2001 and 2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $350 million. From 2001 to 2007, about 26,000 people lost $460 million in forex frauds.

According to Michael Dunn from the US Commodity Futures Trading Commission, currency trading "has become the fraud du jour" (fraud of the day) as of early 2008. However "the market has long been plagued by swindlers preying on the gullible," according to the New York Times. The average individual forex trading victim loses about $15,000, according to CFTC records says The Wall Street Journal.

The North American Securities Administrators Association says that "off-exchange forex trading by retail investors is at best extremely risky, and at worst, outright fraud." They say that; "In a typical case, investors may be promised tens of thousands of dollars in profits in just a few weeks or months, with an initial investment of only $5,000. Often, the investor’s money is never actually placed in the market through a legitimate dealer, but simply diverted, stolen, for the personal benefit of the con artists."

To review some reputable brokers, go to forex broker reviews.

Retail foreign exchange brokers

There are two types of retail forex brokers offering the opportunity for speculative trading: retail foreign exchange brokers and market makers.

It is not widely understood that retail forex brokers and market makers typically trade against their clients and frequently take the other side of their trades. This can often create a potential conflict of interest and give rise to some of the unpleasant experiences some traders have had. A move toward "No Dealing Desk" (NDD) and "Straight Through Processing" (STP) has helped to resolve some of these concerns and restore trader confidence, but caution is still advised in ensuring that all is as it is presented.

Retail forex brokers

Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail forex brokers, while largely controlled and regulated by the CFTC and NFA might be subject to foreign exchange scams.The retail forex (retail off-exchange currency trading or retail FX) market is a subset of the larger foreign exchange market.

It is now possible to trade cash FX, or forex (Foreign Exchange) or currencies around the clock with hundreds of foreign exchange brokers through trading platforms. The reason that the business is so profitable is because in many cases brokers are taking the opposite side of the trade, and therefore turning client capital directly into broker profit as the average account loses money. Some brokers provide a matching service, charging a commission instead of taking the opposite site of the trade and "netting the spread", as it is referred to within the forex "industry."

Recently forex brokers have become increasingly regulated. Minimum capital requirements of US$20m now apply in the US, as well as stringent requirements now in Germany and the United Kingdom. Switzerland now requires forex brokers to become a bank before conducting forex brokerage business from Switzerland.

Market makers

A market maker is a firm that quotes both a buy and a sell price in a financial instrument or commodity, hoping to make a profit on the bid / offer spread, or turn.

In foreign exchange trading, where most deals are conducted over the counter and are, therefore, completely virtual, the market maker sells to and buys from its clients. Hence, the client's loss and the spread is the market maker firm's profit, which gets thus compensated for the effort of providing liquidity in a competitive market. This extra liquidity reduces transaction costs and therefore facilitates trades for the clients, who would otherwise have to accept a worse price or even not be able to trade at all. Most foreign exchange trading firms are market makers and so are many banks, although not in all currency markets.

Foreign exchange brokers usually have to register with some regulatory agency or association. You can find out a lot of information about them including principles names, history, disciplinary problems and complaints by checking out the regulatory agency's website.

Before doing business, ensure you are dealing with a reputable firm.

Some of the regulatory agency's websites are as follows;

USA Go to The NFA's BASIC system

UK Go to The FSA's website

Australia Go to ASIC MoneySmart website

How to Choose a Forex Broker

There are thousands of forex brokers to choose from worldwide, so how do you choose one or two or three? What? Yes, you read correct. I recommend diversifying your trading funds between two or more brokers. The old saying still holds true, "don't put all your eggs in the one basket".

The reality is that nobody knows what tomorrow brings. On the other hand, being in the business of "being a Forex Broker" is very profitable undertaking. Which in turn is positive to clients as the future of the brokerage firms should be long lasting profitable undertaking.

However, remember Barings Bank (1762 to 1995) the oldest merchant bank in London until its collapse in 1995 after one of the bank's employees, Nick Leeson, lost 827 million pounds or 1.3 billion dollars speculating primarily on futures contracts. (Wikipedia Encyclopedia – Barings Bank).

Some brokers offer segregated client accounts, which protect the client in case of the unlikely event of the brokerage firm going bankrupt.

List of considerations to suite your trading requirement can be summarized as follows;

  • What is their minimum account size? Not all forex brokers have micro accounts to limit risk per position.
  • What is their spread? (difference between bid and ask).
  • What leverage do they offer? Are you comfortable with a high leverage account? 50:1? 500:1?
  • How do they earn their money? Through the spread or through a fee/commissions per lots traded? Do they take the opposite side of your trade and get to keep it as their profit if you lose?
  • What kind of services do they offer? Charting / platform quality, other software, news alerts or what other services can assist you?
  • Do they offer full automated trading capabilities? The most popular is Metatrader. (MT4)
  • Almost all brokers offer demo accounts so you can test their system and features first. (Some offer demo accounts that never expire, while others limit them to 30 days). Easy to enter trades? Quotes easy to read? Do you feel comfortable using the trading platform?
  • Reputation. Any regulatory actions against them? (NFA or CFTC).
  • Registered under regulatory agencies?
  • Are client accounts "segregated" for added safety in case of broker bankruptcy?
  • How transparent is the execution of orders? Dealing Desk used or No Dealing desk? Or ECN/STP? Generally, ECN/STP is the better alternative as the broker does not see or touch orders during their execution.

Use a ECN or Non-ECN Account?

Read about brainyforex's experience comparing a ECN Account with a Non-ECN Account. If you or your automated trading system trades on smaller time frames this is a must read here.

Further recommended reading is a excellent article by TulipFX. They consider a metatrader broker PLUGIN which can be used by brokers for their benefit. Read more here.
Take a look at Brainyforex's list of broker recommendations here.

Have you used a forex broker in the past? We would love to hear your experience at brainyforex public reviews. Go there now.

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