The first step you need to do to trade on the forex market is opening a trading account with a forex broker. Some brokers offer better trading conditions than others, and you need to know what to look for when choosing your first forex broker.
This article will guide you through the main points you need to know before choosing a broker.
Video: How to Choose a Forex Broker
What is a Forex Broker
Unlike brokers in the stock market, forex brokers have significantly lower transaction costs. They usually don’t charge commissions and don’t require to trade fixed lot sizes. So how do forex brokers make money? Simply on the difference between the bid and ask price of a currency pair, also called the spread.
Let’s say the EUR/USD pair has a bid price of 1.1755, and an ask price of 1.1757. This 2-pip difference in price represents the income of forex brokers. Furthermore, the flexible lot sizes in forex allow you to open positions of any size you want. That being said, there are still a few notable differences among brokers that need to be addressed before opening your first trading account.
What Type of Broker Do I Need
Forex brokers can be grouped into two main categories:
- Dealing Desk brokers (DD)
- And No Dealing Desk brokers (NDD)
Dealing Desk brokers, also called “market makers”, are acting as a middleman between their clients who want to buy or sell a particular currency. These brokers create the liquidity and market for their client. When placing an order with a dealing desk broker, they will first try to match it with an existing opposite order from their other clients. In case there are no opposite orders, the broker itself has to take the opposite side of your trade, or pass it to other liquidity providers for risk-reducing purposes.
Since they set both the bid and ask price, their spread is usually fixed and doesn’t have to necessarily reflect the real interbank rate (although its close enough). The majority of forex brokers out there are market makers.
No Dealing Desk brokers, on the other hand, can be further divided into STP (Straight-Through Processing) brokers, and ECN+STP (Electronic Communication Network + STP) broker. STP brokers provide direct access to liquidity providers, such as large banks, and charge either fixed or variable spreads for their services.
The other type of NDD brokers, ECN brokers operate on special electronic communication networks, to link both liquidity providers and network participants together in order to offer best possible trading conditions for their clients. They will usually charge variable spreads or commission fees and can require relatively higher deposit requirements compared to the other types of brokers.
The Forex Broker Checklist
Now that you know what a broker is and how they operate let’s look at the 6 most important things that should influence your decision when choosing a broker. We will go into greater detail about each one below:
- Account Security
- Leverage Range
- Demo Accounts
- Charting Platform Integration
- Customer Service
1. Account Security
The most important point when choosing a forex broker is its security. At the end of the day, you want your money to be safely deposited with a broker that is regulated by a relevant financial authority. Some of the most often regulators in forex market include: CySEC (Cyprus), NFA and CFTC (USA), FCA and PRA (UK), and ASIC (Australia).
Make sure you find the broker’s regulating body on its website before moving on with our checklist. A regulated broker will also process your withdrawal and deposit requests fast and without any problems.
2. Leverage Range
Currency pairs usually move less than 1% daily. To be able to profit from those small price movements, a tremendous amount of leverage is available in forex. Leverage is the loan provided by the broker, which can be used to open significantly larger trades than your trading account would allow. The broker will automatically allocate a portion of your account as a collateral for the loan, called the “margin”.
That being said, forex brokers offer a range of leverages, like 50:1, 100:1 or even 800:1. However, you need to be cautious when trading on leverage, as it can magnify not only your profits, but also losses. Financial regulators usually put a cap on the amount of leverage a regulated broker can offer. So, US brokers offer a maximum of 50:1, while the leverage of other regulated brokers is usually up to 100:1 or 200:1.
Although traders can’t avoid transaction costs, they can choose a broker with tight and competitive spreads. However, like anything in life, cheapest is not always the best. In fact, many unregulated brokers will try to attract customers by offering extremely low transaction costs, so don’t fall into this pitfall.
Competitive spreads are anything from 1-2 pips on major pairs, such as EUR/USD, GBP/USD and USD/JPY, and a few pips at most for minor and exotic pairs.
3. Demo Accounts
Before moving to a real account and start trading with money, you should first get a feeling for the market with a demo account. Forex trading involves substantial risk, and you should be absolutely familiar with your trading platform and basic trading concepts, such as position sizes and the impact of leverage, before going real. Most of the forex brokers offer demo accounts today.
4. Charting Platform Integration
The trading platform is your window to the forex market. It should be user-friendly, visually attractive and offer all the features that you may need. Today, most brokers offer desktop trading platforms such as SmartTrader, MetaTrader4 or even our own platform the Ultimate Charting Software (shameless plug, I know) in addition to some in-house solutions, mobile apps or web-based platforms.
Make sure your broker of choice offers the platform that best suits your needs. For example, in times when you don’t have access to a computer, being able to manage your trades on your smartphone is very important.
5. Customer Service
Last but not least, a great forex broker should also have a great customer service. Unexpected situations happen along the way, and you need to be sure that your broker will resolve all your problems in a timely manner.
It’s equally important that you can contact your broker in a number of ways, such as via chat, telephone, or e-mail, and you can give your broker a quick call before you open an account to check what the waiting lines are and how reliable and accurate the customer service is in answering your questions.