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Choosing a Forex Broker

Since Ive received such an overwhelming amount of emails from readers requesting for more information on broker selection, Ive decided to put together a small comparison of the two types of brokers out there. I hope you will find this useful, and if you have any comments or suggestions, feel free to contact me.

As you may already know, foreign exchange (Forex/FX) is an unregulated market that is not traded on an exchange, which means that prices you see and get from one broker could vary from those of another broker.

There are mainly two types of brokers. One type is an ECN (Electronic Communication Network) and another a Market-Maker.

Market-makers make or set the prices on their systems based on what they think is best for themselves as the counter-party. This is because every time you sell, they must buy, and when you buy, they must sell to you.

This is why they can give you a fixed spread since they are setting both the bid and the ask price. Many of them will then try to hedge or cover your order by passing it on to someone else; however, some may decide to hold your order, and thus trade against you. This can result in a conflict of interest between the retail trader (you) and the market-maker.

ECNs, on the other hand, pass on prices from several banks and market-makers, as well as from the other traders in the ECN, and display the best bid/ask prices based on these input. This is why sometimes you can get

no spread on ECNs, especially in very liquid currency pairs. How do ECNs make money then? They do so by charging you a fixed commission for each transaction.

Here are some of the pros and cons of ECNs and market-makers:

Market-Makers

Pros:

* Usually give free charting software and news feed

* Prices can be smoother and less volatile than ECN prices (this can be a con if you are scalping or trading very short term)

* Often have a more user-friendly trading and analysis interface

Cons:

* They may trade against you. In that case, there will be a conflict of interest between you and them

* The price they offer you may be worse than what you could get on an ECN

* It is possible that they may trigger stops or not let your trade reach your profit target levels by manipulating prices

* During news, there will usually be a large amount of slippage; their systems may also lock up or not allow order placing during times of high volatility

* Many of them discourage scalping and put scalpers on manual execution which means their orders may not get filled at the price they want

* Dealing desks use software that constantly re-quotes a price when you are trying to get into and out of a trade. this is essentially stealing pips from you

Examples of some market-makers:

ECNs

Pros:

* You can usually get better bid/ask prices since they come from several sources

* Variable spreads between bid and ask may give no spread or tiny spreads at times

* If they are a true ECN, they will not be trading against you but will pass on your orders to a bank or another customer on the other end of the transaction.

* You will be able to offer a price between the bid and ask with a chance of it getting filled

* If they support Stop-Limit orders, you can prevent slippage during news by making sure that your order either gets filled at the price you want or not at all

* Many do not offer integrated news

* Many of the trading platforms are less user-friendly

* Because of variable spreads (between bid and ask,) it may be more difficult to calculate stop loss and profit target in pips beforehand.

(note: FXCM told me that they now offer a No Dealing Desk execution option, and they are no longer a market maker)

* Some of these ECNs may not be true ECNs, and you may be going through a dealing desk. It is impossible to verify for sure because of the lack of regulation governing forex brokers. Just because they say they are an ECN, doesnt make it true.

The industry needs to enforce better “truth in advertising” laws, and we’re seeing that more and more.

You can’t pretend that you aren’t a dealing desk just because people like to hear you say that, but then make your money in the spread.

If you aren’t charging a fee for providing a customer with an execution and you aren’t showing market depth, then by definition, you are a dealing desk. Period.

However, there are now hybrid brokers that don’t show you market depth, don’t charge you a transaction fee (commission), but do pass your large lot size trades directly to a bank (called STP or Straight Thru Processing). and don’t re-quote you, stop hunt or otherwise trade against you. They have slightly wider spreads than a true ECN but not as wide as a dealing desk. They might call themselves an ECN because they are not really a dealing desk and they want you to keep winning because they make their money on your trading volume.

A good example of this new type of hybrid STP broker is ThinkForex. highly recommended, with only $500 to open a live account.

BENEFITS OF USING AN ECN PLATFORM:

1. no anti-scalping, no stop-loss hunting, very low spreads;

2. trade in a true non-deal desk environment;

3. get the most competitive spreads & 5 digit precision pricing;

4. no re-quotes;

5. you can scalp or trade news without restrictions;

6. EAs allowed and with no prejudice;

7. pending orders can be placed inside the spread;

8. your pending orders, stops & profit targets are not visible to

brokers, banks or any other market players until filled.

Summary

It is important that you carefully look into the pros and cons of each broker before choosing the one which best suits your needs. You may also wish to have several broker accounts to mitigate the risks. and so that you can compare bid/ask prices and trade on the broker with the best prices for the direction you wish to trade.

Because of the unregulated nature of forex, US brokers are not required to keep your money in an untouchable account that only you can have access to if they were to collapse. As customers of Refco (was one of the worlds largest brokers) found out, their unprotected accounts made them unsecured creditors, and thus are less likely to get their money back than those who had given secured loans to Refco. What this means is that the customers money was used to pay other creditors.

The moral of the story is this:

Deposit as little money with your broker as you need for trading, and withdraw your profits when they exceed a certain amount. Keep the rest of your trading capital in your own bank accounts which should be

government-insured.

It is HIGHLY recommended that you investigate brokers and individuals through the NFA and CFTC websites before you decide to do business with them.

Here are the links:

To check up on a US brokerage or US individual for complaints, infractions, sanctions, fines and penalties, etc. go to:

Youll need the brokerages NFA resistration #, usually found

on their website. If you cant find a NFA #, then chances are

good that it isnt registered for some reason (not U.S.-based

or temporarily or permanently barred from membership due to