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1.6 Choosing an Online Broker

With hundreds or even thousands of online Forex brokers to choose from, the abundance of choice can be bewildering. How to know which one of these brokers is right for you when you are ready to choose an online broker?

In this lesson, we will explain a little about how online Forex brokerages work, and outline the important questions you should ask in determining which one to open an account with, when you are finally ready to take that step.

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Choosing an Online Broker - Text Version

Choosing an Online Broker

In the previous lesson, we showed how the supply of and demand for currencies changes price. Now we are going to talk about how Forex traders actually make trades.

The Mechanics of Online Trading

Unlike stocks and shares, there is no central Forex market. For example, if you buy or sell the stock of a company that is listed on the New York Stock Exchange, you have to do it through the exchange itself. Everyone gets the same prices.Forex is different. You can exchange currencies anywhere, and it is the biggest market in the world. Most of the currency traded comes from four large banks that do not deal with retail clients like us. Instead, retail traders with accounts from a few hundred to thousands of dollars trade Forex through Forex brokers.Forex brokers are companies which provide an opportunity for us to trade Forex over the internet in small  sizes. There are some banks that also offer Forex brokerage services to larger retail clients. How to choose a broker, then? We’ll talk about the different types of brokers later on, but what’s most important are the things you should consider when you are deciding where to open your Forex trading account.

How to Choose a Broker

The security of your money is the most important concern. You should be able to withdraw your money whenever you want to. Find out if you are protected by some kind of deposit insurance, and check the reputation of any broker with your country’s financial regulators. Avoid any brokers that look financially unhealthy, or have bad reputations about paying their clients.
Next, you should think about any legal or tax issues that might affect you. For example, residents of the U.S.A. are subject to tough regulations governing foreign brokerage accounts. Tax residents of the U.K. can enjoy freedom from U.K. taxes on any winnings if they use spread betting companies instead of traditional brokerages. Obviously you don’t want to get into any trouble, or pay any unnecessary taxes.Once you’ve found out which brokers you can safely trade with, you are ready to compare what is on offer. Areas that you should consider include:

•    Reliability and speed of trade execution. It’s important that you can enter and exit trades as soon as you want. You don’t want to see a broker’s server go down just when you want to make a market order!

•    Commissions / Spreads. Spreads – the difference between a currency’s buying and selling prices - should be competitive, and if you trade very often or in large quantities, it might make more sense to pay fixed commissions instead of spreads. Spreads effectively are a commission your broker charges you on every trade you make.

•    Range of currency pairs offered. Some brokers offer you the chance to trade more currency pairs. This might not be so important to a new trader, who could be sticking to the major pairs, which usually have cheaper spreads or commissions.

•    Quality of customer service. If you have a technical problem or there is something you don’t understand, you need to be sure you’ll get help fast.

•    Platform. Many brokers offer their own customized trading platform, either browser-based or downloadable software. Many brokers offer the Metatrader 4 or 5 platforms, which we will talk about in a later lesson. You need a platform that runs smoothly and is comfortable to use, because if you make a mistake trading, it might cost you money.

•    Type of trading. Some brokers will not work with clients who make lots of fast, short trades over very small fluctuations in price. This kind of trading is called “scalping”.

In this lesson, we’ve talked about how Forex traders actually make trades, and the questions you should be asking in choosing a forex broker, to find a secure Forex broker who meets your needs.

Additional Reading About Choosing an Online Broker

Be aware that most retail Forex brokers do not actually buy and sell any currency in the market.

They simply allow their clients to bet on the movement of the prices they are quoting.

You don’t have to worry about this too much, because if their prices aren’t almost the same as whatever the major banks are quoting interbank, they will be put out of business by smart traders exploiting the difference. This fact alone should usually ensure that prices are honest. The fact remains that the broker’s quoted prices are created by the broker.

You should be aware that these brokers lose money when their clients win trades, and make money when their brokers lose trades.

There follows another implication from this that is worth considering. If a broker does not cover their client’s trades to some extent in the real market, then they will go bankrupt if enough of their clients win consistently and ask for withdrawals of their funds. Some brokers mirror the trades of their clients with winning records in the real market to protect themselves against such a thing happening.

It can be said that most of today’s retail Forex brokers are similar to the “bucket shops” that were prevalent in late 19th / early 20th century U.S.A.

Having said that, this does not mean these brokers are necessarily dishonest, because they can make money from the spreads and/or commissions they charge, as well as from the sad fact that most retail traders lose money over time.

However, dishonest brokers might succumb to a strong temptation to create a very fast temporary price spike into levels where many of their clients will have placed stop losses on their open trades. Sometimes the true market acts in this way in any case, but if you see a spike like this on your broker’s price feed that is not reflected in the wider market, you should move your account somewhere else, but ask first for a refund on any losing trade that was caused by the spike.

You should also be suspicious of brokers who widen their spreads way beyond the rest of the market, or who won’t accept your trades through their platform when the market is running strongly in your favor. Once this happens two or three times in succession, you should consider moving your account elsewhere.

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