ForexSpirit

To make money at foreign exchange trading you must deposit some of your hard earned money with a forex broker. But which broker do you go with?

There are eight main factors that I like to consider when making this decision:
1. Regulatory oversight
2. Safety of your funds
3. Leverage/Margin/Gearing
4. Lot sizes
5. Interest/swap rates
6. Ease of use of software
7. Reports
8. Telephone support

Let’s take a look at each of these in turn.

1. Regulatory oversight

To make sure that the broker is not a bucket shop or other type of ‘fly-by-night’ operation you should check to see if the broker is registered with the appropriate offical financial associations in the country where it operates.

For brokers based in the United States you should check out the NFA and CFTC websites. If the broker purports to be a member of the National Futures Association (NFA) you can double check this by doing a search for them on the National Futures Association’s Background Affiliation Status Information Center (BASIC) search page.

Another interesting check that can be done is to see how much capital your broker currently has. If the broker is registered as a Futures Commission Merchants (FCM) you can perform a check on the Commodity Futures Trading Commision’s website for the broker’s financial data here. Just download the most recent .pdf or Excel file to see how much capital the broker has reported to the CFTC. Make sure to check out the Adjusted Net Capital, Net Capital Requirement and especially Excess Net Capital figures.

If you are unable to find the broker as being listed, double check to see if the broker’s parent company is registered. For example, FXDirectDealer (FXDD) is a subsidiary of Compagnie Financière Tradition, and is registered with the NFA and CFTC as Tradition Securities and Futures Inc.

If you live in the United Kingdom then you need to check with the Financial Services Authority.

2. Safety of your funds

Since the number one priority of any trader should be to preserve their trading capital, the safety of your funds is of vital importance when choosing what broker to do business with. You don’t want to find yourself in the same position as what happened after the Refco scandal, where customer accounts were frozen for a long period of time.

Make sure that client funds are in placed in a segregated account. This means that money you deposit with the broker is keep in a separate bank account from money that is used to run the day-to-day operations of the company. You don’t want the broker using your money to pay the salaries of its employees.

It is also beneficial if the broker has insurance such as a Fidelity Bond 14 from a reputable insurance company. This insurance is to protect the assets of the broker against loss resulting from fraudulent acts committed by the management or employees of the company. In the unlikely event of fraud, theft, or embezzlement the bond should offer sufficient protection so that the company does not have to declare itself bankrupt (whereupon it becomes almost impossible for you to extract your money).

This type of extra insurance does not insure against your risk exposure on market loss.

You also need to be aware that there is always the possibility that you can lose more money on a trade than you have in your account. Let’s take a look at an example of how this might happen:

Let’s say that you have deposited $1000 with your broker. You decide to place a 100,000 lot trade on EUR-USD. This means that each pip move results in a $10 change to your unrealized balance. Let’s imagine that price goes against you by 75 pips. This means that you’re down $750, and have just $250 left of your original $1000.

Suddenly there is a huge gap in the tick price and price has in an instant jumped another 50 pips against you. This price jump has in one fell swoop completely bypassed your margin call level. Your broker immediately closes the trade automatically for you, but you have still managed to lose more money than you originally had in the account. The 50 pip spike move means that when the trade was closed you were actually 125 pips in the red. This means that you actually lost $1250, and thus are $250 in debt to the broker.

Market prices do not always move in smooth one pip increments. It can jump multiple pips at a time. For evidence of this you only need to look at a tick chart around any major economic news release.

3. Leverage/Margin/Gearing

Your trading system will dictate what your maximum gearing will be at any one time. This is the maximum size of all open positions in relation to the size of your actual trading capital.

Most forex brokers offer leverage far in excess of what most sensible trading system need. You might even find that the broker offers better roll-over rates the lower your chosen leverage level. If your trading system has you never exceeding gearing of 50:1, then there is no real advantage to choosing leverage of 100:1 or 200:1.

The only other factor that might impact your decision is the margin call level, which most brokers tie in directly to the selected leverage level. Given the projected maximum drawdown of your trading system and your maximum gearing level, you should be able to work out if you need to worry about the margin call level at all. As a general rule of thumb, if you expect to have your account balance approach anywhere near the margin call level then there is a pretty fundamental flaw with your trading system.

4. Lot sizes

A lot size is the smallest number of units of the base currency in a currency pair that you are allowed to buy or sell.

The standard inter-bank lot size is 100,000 units. If you bought a standard lot of EUR-USD you would be buying 100,000 euros.

Most retail brokers now offer mini-lots which are equivalent to 10,000 units.

You can also find some brokers that include micro-lots, which are 1,000 units.

The only other varieties that I know about are GFT who offer a Base-10 system, where you can buy lots in multiples of ten units, and Oanda, who allow you to buy any number of units that you wish.

In order to be able to apply sound money management policy as part of your trading, it is vital that you do not under fund your trading account. Underfunding your account means that you deposit too little money in relation to the minimum lot size that you allowed to use for a single trade.

I have a simple rule of thumb that I go by: your trading balance should be at least five times that of the minimum lot size available to you.

Let’s say you are using a mini lot account and only trade on EUR-USD. If price on EUR-USD is at 1.3000, what should your minimum account balance be?

The answer is $65,000. 10,000 x 5 x 1.3.

If you’re able to use micro-lots then you only need a tenth of that: $6,500. 1,000 x 5 x 1.3

Choose a broker that is going to allow you to implement sound money management strategies. If you are looking to only fund a small amount of money to your brokerage account, then look to choose a broker that offers small lot sizes, such as Oanda.

5. Interest/Swap rates

Brokers will offer widely differing interest rates for holding various currency pairs. The best interest rates are normally only offered to institutional clients (these will be large companies with far more money than you are likely to have). It is always beneficial to use a broker that offers you interest rates as close to the instituational rates as possible.

Make sure to compare the interest rates between the brokers that you are considering using.

Some brokers openly advertise the interest rates that they offer. For example, InterbankFX displays theirs on this swap rates page. With other brokers you might have to get in contact with their support or sales staff to find out what rates they offer.

Some brokers show their interest rates via buy and sell premium rates (which are expressed in percentage terms) while others show the dollar amount that is gained (or lost) via the interest rates when holding 100,000 units of the base currency.

How do you compare the two?

It is quite easy to convert between the two methods.

If you want to convert from the premium rates to knowing how much it equates to in daily dollar terms you would use the following equation:

100,000 * ( (Premium Rate / 100) / 365 )

If you remember any of your school math you should be able to see that the equation can be easily simplified to look like this:

Premium Rate / 0.365

So all you need to do is take the premium rate (either the buy or the sell) and just divide it by 0.365. You can then use the resulting number to compare it with the daily dollar amount paid out by a broker that does it that way.

You can easily reverse the process and calculate the premium rate given the daily dollar amount.

Just multiply the daily dollar amount by 0.365 instead.

6. Ease of use of software

Open a demo account with a prospective forex broker. Download their trading software along with any support documentation on how to use it. Experiment using the software to see if you like it or not.

You are more than likely going to be entering a lot of orders no matter what trading system you follow so you must feel comfortable with the software you use. User preference has a large role to play here and whether the software has the features that you require.

7. Reports

Another area that comes down to personal preference more than anything else is the reports that the broker can present to you on your trading activity.

For example, many people find the trading reports produced by GFT to be very confusing (I am one of them). On the other hand, the reports produced by most other brokers are much simpler to understand. GFT says that their reports are more ‘correct’. If you were a large bank or accountant then you might actually prefer it this way. Unfortunately, GFT is a retail forex broker, so I fail to understand why they don’t produce reports that are in-line with the way just about every single other forex broker does them. There’s nothing from stopping them keeping their current reports, but why they don’t offer more understandable reports I just don’t know.

Make sure to test the reporting aspect of any broker that you demo with to make sure that you comfortable with the way that they record your trading activity.

8. Telephone support

You never know when there is going to be problem with your computer or any other aspect of the internet that connects your machine to that of your broker’s servers. With this in mind, it is important to be comfortable with phoning the broker up to place or change any of your orders if the need should arise.

It is a good idea to phone them up and place an order even if you are not experiencing any technical difficulties. It gives you a chance to test their phone operations as well as keeping you comfortable with being able to place orders over the phone. Place your broker’s phone numbers in an easily accessible place. You don’t want to find yourself in a situation where you’re scrambling around trying to find your broker’s contact details after a power cut hits just before you had a chance to enter your stop loss on a new trade you’d just placed.

Being able to trade electronically is a relatively new phenomenon, so don’t be afraid to go old school and use your phone to conduct your trading. You never know when it might come in vitally handy!

Are there any other main factors that you take into account when choosing a forex broker to do business with?