CHOOSING THE RIGHT BROKER IS ESSENTIAL FOR FOREX TRADERS - Lesson 4
In this lesson you will learn:
- How to choose the Right Broker
- The ECN Broker Business Model
- The difference between an ECN Broker and a Market Maker
There are many forex brokers, listed on various on-line directories, who you can choose to trade with. You may have been recommended a broker by a friend, or choose a broker through an advert you've seen on the internet, or through a review you've read on a specialist forex trading website, or forum. However, there are certain basic questions you should ask and queries you need satisfying, before you commit your funds to any broker.
Regulation
Where is your chosen FX broker based, under what jurisdiction are they monitored and how effective is their regulation? For example, Cyprus based FX brokers business practice is overseen by an organization known as CySEC, who have the following responsibilities:
- To supervise and control the operation of the Cyprus Stock Exchange and the transactions carried out in the Stock Exchange, its listed companies, brokers and brokerage firms.
- To supervise and control Licensed Investment Services Companies, Collective Investment funds, investment consultants and mutual fund management companies.
- To grant operation licenses to investment firms, including investment consultants, brokerage firms and brokers.
- To impose administrative sanctions and disciplinary penalties to brokers, brokerage firms, investment consultants as well as to in any other legal or natural person whom fall under the provisions of the Stock Market legislation.
In the UK, brokers have to abide by the rules and regulations set out by the FCA (the financial conduct authority). In the USA, all forex brokers (including who are termed "introducing brokers") must be registered with the National Futures Association (NFA), the self-regulating governing body which provides the regulatory framework to ensure: transparency, integrity, that regulatory responsibilities are met and the protection of all the various market participants.
No Fees
Traders should be trading forex with a broker who charges no fees for transacting trades. Ethical, responsible and fair brokers should profit only on the small mark up, made on the spread of each trade. For example; if you're quoted a 0.5 spread on a currency pair, then the broker may make a 0.1 profit on the actual trade. There should be absolutely no other fees relevant to your account. Unless you're operating a small account, with a minimum level of perhaps $100 deposited, in which instance the broker may have to level a small fee in order to make it cost efficient for both parties. However, as a percentage of the funds deposited, the fee will be incredibly small.
No Swap Fees
Reputable forex brokers will not charge for holding your positions overnight, or charge for what are termed "swaps".
Low Spreads
You should only trade with brokers who operate variable spreads, fixed spreads simply do not exist in the fast moving market place that is forex trading. Therefore if a broker is offering a fixed spread on, for example; the major currency pairs, they can only do it by manipulating the spreads. They can't be offering what's termed a straight through processing service into an ECN (electronic configured network), which is a liquid pool of constant quotes supplied by mainly the major investment banks.
Ease of Withdrawal
How easy it is for you to withdraw your profits, or to transfer any funds out of your trading account, is an important measure of the quality of the organization you're dealing with. There should be sections on the broker's website covering the exact procedure to follow in order to withdraw your funds to protect both parties. It should cite how long the process takes and the regulations the broker has to abide by, in order to adhere to many money laundering regulations put in place by the governing body, such as: CySEC, the FCA, or the NFA.
STP/ECN
Traders should ensure they're dealing as close to the 'real' market as possible. They should trade in the most professional manner available. Straight through processing, into an electronic configured network, ensures that retail traders are conducting their transactions in a similar manner to experienced professionals, who'd typically be hired at institutional level trading firms and tier one banks.
It's in the interest of an STP/ECN broker to help their clients profit; the more successful the client is the more they're likely to stay loyal, satisfied clients. Given that the only profit an STP/ECN broker will make is on the small mark up on the spread, they'll always ensure orders are filled as quickly and as closely to the price quoted, the vast majority of the time.
No Dealing Desk
A dealing desk is a barrier to your access to the market. Think of a dealing desk as a gatekeeper allowing you to only be let into the forex market when the dealer decides it's best for them. Dealing desk operations trade against the client, they do not route your order to market in order for your order to be filled at the best price available, they decide on what price to fill your order at.
No Market Making
Similar to a dealing desk situation, traders would be best advised to ensure that they avoid firms who make a market in the securities (Forex pairs). Market makers also trade against their clients, as with dealing desk operations, they profit when their clients lose. Therefore it's questionable as to how helpful they'd be to their clients.
What is an ECN Broker?
ECN, which stands for Electronic Communication Network, really is the way of the future for the Foreign Exchange Markets. ECN can best be described as a bridge linking smaller market participants with its liquidity providers through a FOREX ECN Broker.
This linkage is done using sophisticated technology setup named FIX Protocol (Financial Information Exchange Protocol). At one end, the broker obtains liquidity from its liquidity providers and makes it available for trading to its clients. On the other side, the broker delivers clients' orders to Liquidity Providers for execution.
The ECN automatically matches and executes the orders requested, which are filled at the best available prices. One of the extra benefits of ECNs, over and above the existing legacy online trading venues, is that the networks can be accessed and are often more efficient during "after hours" trading, which is a particularly relevant benefit for forex transactions.
ECNs are also highly efficient for traders operating EAs (expert advisors) for automated trading, as the speed of execution is accelerated. Certain ECNs are configured to serve institutional investors, others are designed to serve retail investors, while others are compiled to cross over between both sectors, ensuring that retail traders can experience similar levels of quotes and spreads to that of institutions.
An ECN broker benefits from commission fees per transaction. The higher trading volume the broker's clients generate, the higher the broker's profitability.
That unique trading model ensures ECN brokers never trade against their clients and that ECN spreads are much tighter than those quoted by standard brokers. ECN brokers also charge clients a fixed, transparent commission on every transaction. Trading with FXCC as part of the efficiency delivered by an ECN, results in lower fees, whilst there is the added benefit of additional trading time availability. Because we gather price quotations from several market participants, we are able to offer our clients tighter bid/ask spreads than would be otherwise available.
The Difference between ECN and Market Maker
ECN Broker
In simple terms an ECN broker allows its clients to access a pure forex trading market; an electronic configured market, whereas a market maker broker makes a market in forex pricing and profits from trading against their clients. A market maker operates a dealing desk model; they act as gatekeepers to decide who gets the prices quoted matched and when. The opportunity to deal against clients in favor of the broker, leads to criticisms of dealing desk/market makers, regarding their overall probity.
Market Maker
A market-maker can be defined as a broker-dealer firm that publicly quotes both a buy and sell price for a currency or commodity traded on a regular and continuous basis. Market makers compete with each other for clients by offering the best prices (spreads) for their clients.
Market makers, often propose to offer tighter and lower spreads to other brokers. Market makers sell on the basis that they don’t charge commissions, or add mark ups on spreads to the institutional rates they deal in and can offer consistently better pricing than middleman, allowing clients to enjoy the liquidity benefits that banks and for example hedge funds would enjoy. However, market makers are not operating in a pure and real market, the market is synthetically made, and it’s unrepresentative and subject to potential manipulation by the market maker broker, for their benefit and not their clients.
