Selecting A Right Forex Broker
Whether you are a retail or small institutional forex trader, we all need to trade through a forex brokerage firm. The bigger you are the closer you move to the major market participants – banks, mutual funds, hedge funds, large investment firms. They take up about 75% of the forex market capitalization. Some banks could be brokers themselves. The remaining 25% are individual traders like you and me, and small trading firms.
Selecting a right forex broker is not a static activity. It is a dynamic one depending on one or more of the following factors:
- Regulated or non-regulated forex brokers.
- What stage of your trading career you are in. You trade for your own money or manage other people’s money as well.
- Amount of your trading capital.
- Services of a particular forex broker that address your requirements for trading.
- Tax implications if you open trading account with a broker domiciled in U.S. or U.K. or Switzerland or tax haven countries like Hong Kong, Singapore, British Virgin Island, Bermuda, Cyprus, so on.
- Changes of the industry regulations. For example, a new leverage of 50:1 (the old one was 100:1) imposed on U.S. based forex brokers effective on October 18, 2010 has already impacted on traders having accounts with them.
Unlike the stock and commodity markets, the forex market is loosely regulated. Regulation is voluntary rather compulsory. Brokers that choose to be regulated hopefully luring in more clients opening accounts with them. Having your fund deposited in a regulated forex broker certainly enhances the chance of your fund safety. Details of this issue are discussed in the section ‘Safety of Your Funds’.
If you’ve just started out or are exploring a forex trading career, there are many choices of brokerage firms out there for you today. Your objective in this stage is probably to test the water. You could deposit a couple of hundred or thousand dollars. This is a relatively small amount of trading capital. However, when you progress with your trading career, tens of thousands or even hundreds of thousands or millions dollars are large amounts of money, your most concern would be the safety of your fund.
On the other front, some individual traders and trading firms are concerned about minimizing tax expenses, they may choose to open accounts with a particular country domiciled broker for the tax purposes. At this point in time, U.K and Switzerland based brokers are probably popular choices because these countries are tax havens as well as having well established regulatory bodies for the forex market. Other Caribbean tax haven countries like Anguilla, Bahamas, Barbados, Bermuda, British Virgin Islands, Cyprus, etc; Panama, the Russian Federation, Costa Rica, might lack such well established regulatory bodies. At this time of writing, some forex brokers setting up offices in Hong Kong and Singapore are on the rise to provide clients with better regulatory reputation and tax advantage.
Due to the recent collapses of large and well established financial giants like Lehman Brothers (U.S.), Northern Rock (U.K), Kaupthing, Glitnir, Landsbanki (Iceland), and other smaller financial institutions all over the world, have had implications on other financial markets including forex. One of the evidences is that, in October 2010, the National Futures Association (NFA) in U.S. imposed new leverage rates of 50:1 for major currency pairs and 20:1 to the cross ones from the standard 100:1 to retail clients from all forex brokers domiciled in U.S., while brokers outside U.S. have no impact from the changes. By saying that, it doesn’t mean either a positive or negative news, it depends on who looks at it! For a minority of winning traders it doesn’t matter too much as there are always better opportunities arising from the changes, while the majority of losers keeps complaining about the changes.
Successful traders consider their brokers as a risk point in their trading systems. So they understand the rules of the game and do everything they can to minimize the risks associated with the brokers. So what are the risks associated with the forex brokers?
Forex broker firms could go bankrupt like any other businesses. Here are some examples: Crown Forex SA based Switzerland went bankrupt in May 2009; U.S. based Refico went bust in October 2005; and you can find many more in the media.
So how to protect your fund when your broker goes bankrupt?
Firstly, selecting brokers who put your fund in a segregated account from their firms’ ones only. In case of bankruptcy, your fund would have a higher chance of being returned to you.
Secondly, going for brokers who are voluntarily registered with a well established regulatory body like NFA (National Futures Associations) and CFTC (Commodity Future & Trading Commission) both in U.S., or FSA (Financial Services Association) in U.K., or ASIC (Australian Securities and Investments Commission) in Australia, or probably SFBC (Swiss Federal Banking Commission) but be careful about Swiss based brokers! At least, these regulated brokers, by complying with the regulations, file their regulatory standing on a regular basis and you can track them on the regulators’ websites.
Frauds and Scams:
Up to date, the forex market is not centralized like the stock, futures and options markets in which all selling and buying are done through central exchanges. For this very reason, there is plenty of room for frauds and scams to occur in the forex market. Like any other traditional businesses, frauds and scams do occur regardless of individuals or institutions involved, level and credibility. Who would be in doubt that Bernard Madoff, once the chairman of reputable NASDAQ exchange in U.S, was one of the biggest fraudsters on the individual as well as institution basis in our history. Other cases including Worldcom, Enron, so on, are examples of high profiled institutions, not mentioning many other smaller cases. An individual or a company putting up a nice front office and a website with many eye-catching stuff and claims, investing in infrastructure like trading and back-office processing softwares, does not mean ‘being cleared off’ from the potential frauds and scams.
Frauds and scams occur in many forms and shapes, ranging from dishonest practices in mixing your fund with their firm’s one, executing your orders at your disadvantage, re-quotes, ‘legally’ trading against their clients, back office manipulation; to larger scales like ‘stealing’ millions or even billions of dollars from investors or traders’ funds.
By saying that, it does not mean to be scared off or to stay away from the forex market. Rather we understand them and take necessary steps to minimize them. Frauds and scams are always there in any market, not just the forex market.
In the sections that follow describe key factors that you may need to consider when selecting your forex broker.
Safety of Your Funds:
Being a successful forex trader is a long-term journey and a life-time achievement for most traders. On average, it takes 5 to 10 years to realize significant rewards for such a worthy pursuit.
In this game, it’s simply that ‘no capital no game’. So protection of your trading capitals should be of the highest priority. Do not let another ‘Bernard Madoff’ steal your money! Below are some recommended criteria for you to seriously consider before opening a live account with a forex brokerage firm.
Is Your Forex Broker Adequately Regulated?
Since the forex market is not strictly regulated, unlike the stock, futures and options markets, only select brokerage firms registered with at least one of a well established regulatory bodies listed below. This will help you minimize the risks associated with the unregulated market. These risks may include firm bankruptcy, frauds and scams as mentioned above.
Up to date, there are five ‘trustworthy’ regulatory bodies for the forex market in the major financial centers in the world. They are:
- NFA (National Futures Association, website:-) in the United States of America.
- CFTC (Commodity Futures Trading Commission, website:-) in the United States of America.
- FSA (Financial Services Authority) in the United Kingdom.
- ASIC (Australian Securities and Investments Commission, website: -) in Australia.
- SFBC (Swiss Federal Banking Commission, website:-) in Switzerland. Be careful for brokers only registered with the Swiss authorities! Switzerland is well-known for its reputation as one of the world’s major financial centers, especially in banking. The problem is that some people have been exploiting its lax financial market regulations for frauds and scams.
You can check if a broker is registered with one of the regulatory bodies above by their ID or name. If yes, then you would see their registration information, name of principles, history of complaints against the firm, so on.
Regarding complaints, there is a subtle discretion that needs to be viewed in balance. Firms with larger number of clients are more likely to have more complaints. So other factors like the firm’ capitalization and client base need also to take into consideration.
Capitalization Of A Forex Brokerage Firm:
When a brokerage firm is registered with a regulatory body, that firm must meet a minimum requirement of capitalization required by that regulatory body. At this time of writing, the minimum capitalization requirements from different regulatory bodies are:
- NFA: 5,000,000 USD
- CFTC: 1,000,000 USD
- FSA: (Will be updated later)
- ASIC: (Will be updated later)
- SFBC: (Will be updated later)
The above capitalization requirements at least minimizes some ‘bucket shops’ out there with an eye-catching website to prey on their clients. However, it does not mean your trading capital is surely protected.
Is Your Trading Capital Put In An Account Segregated From Broker Firm’s Fund?
Only select forex brokers who put your trading capital in a segregated account from the firm funds. The segregated client account is usually with a bank under the brokerage firm name, in which all client funds are pooled together, or individual client name depending size of your trading capital and negotiation with the broker.
The first protection of having such a segregated account is to prevent the brokerage firm from putting their hand in the fund for the firm’s investments or any financial obligations. In U.S., NFA and CFTC rules do not accommodate such fund segregation.
The second protection is that when a brokerage firm goes bankrupt. In U.K., according to FSA, client funds are protected from the firm’s secured creditors or liquidators, so you will most likely get back your fund. In Switzerland, according to SFBC, your fund is treated as unsecured creditor, so you are the last on the list to receive refund if any left!
Fund Deposits And Withdrawals:
I found that most forex broker websites just focus on methods of deposits and withdrawals offered by them but there is a serious lack of clear description of hidden fees born by their clients for each method.
Now let’s look at hidden fees associated with each method of deposit or withdrawal that some brokers out there have deliberately hid from their clients or for whatever reasons.
The beauty of deposit from or withdrawal to credit card is that you can do it online hence saving lots of your time. Also transaction is completed in the shortest time-frame. Fund appearing on your trading account is usually within 24 hours since transaction; or max. 5 business days for withdrawal. The drawback is that credit card companies limits the max. amount of transaction at one time, typically 2000 USD; and max. amount within a calendar month, typically 10,000 USD. So if you like to transact 5,000 USD you have to do it three times: 2000 USD, 2000 USD and 1000 USD.
When you deposit your fund into your trading account with a forex broker, the credit card company charges you a percentage for service, usually ranging from 2% – 5%. For example, if you deposit 1000 USD the credit card company will charge you 20 USD – 50 USD for service, hence you will see only 980 USD – 950 USD appearing on your trading account.
Similarly, when you withdraw your fund from the trading account into your credit card, you will be charged a similar percentage for service. One way to avoid this charge is to have an ATM bank account linked with your credit card. The deposit will go into this ATM card instead of the credit card.
One notion that you may need to pay attention is that the exchange rate at the time of deposit or withdrawal is determined by your bank. This exchange rate may affect overall loss / profitability to your trading business.
Wiring transfer is probably the most popular method for deposit or withdrawal.
Today wiring transfer can be done online hence saving lots of your time. Most banks charge you a fixed rate, typically 25 USD – 40 USD depending on domestic or international transaction, regardless of the transacted amount.
Some forex brokers accept deposits by check. It typically takes 5 business days to clear the check. Also there is fee associated with check transaction and ask your bank for this fee charge.
PayPal, Webmoney, Moneybookers, PerfectMoney, e-bullion, Neteller, AlertPay, Liberty Reserve, so on, are other online deposit/withdrawal methods offered by forex brokers today. They are usually safer than credit card transaction. However, there also are fees associated with transactions from these payment service providers, so you have to dig deeper into these fees before applying for these online money services.
In the next article I will talk about the BROKER PRACTICES and others… stay tuned.
Experience luck everyday toward your fortune.
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