DYNAMICS OF SELECTING A RIGHT FOREX BROKER
Whether you are a retail or small institutional forex trader, we all needto trade through a forex brokerage firm. The bigger you are the closeryou move to the major market participants – banks, mutual funds,hedge funds, large investment firms. They take up about 75% of theforex market capitalization. Some banks could be brokers themselves.The remaining 25% are individual traders like you and me, and smalltrading firms.
Selecting a right forex broker is not a static activity. It is a dynamicone 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 yourown money or manage other people’s money as well.
- Amount of your trading capital.
- Services of a particular forex broker that address yourrequirements for trading.
- Tax implications if you open trading account with a brokerdomiciled in U.S. or U.K. or Switzerland or tax haven countrieslike Hong Kong, Singapore, British Virgin Island, Bermuda,Cyprus, so on.
- Changes of the industry regulations. For example, a newleverage of 50:1 (the old one was 100:1) imposed on U.S. basedforex brokers effective on October 18, 2010 has alreadyimpacted on traders having accounts with them.
Unlike the stock and commodity markets, the forex market is looselyregulated. Regulation is voluntary rather compulsory. Brokers thatchoose to be regulated hopefully luring in more clients openingaccounts with them. Having your fund deposited in a regulated forexbroker certainly enhances the chance of your fund safety. Details ofthis issue are discussed in the section ‘Safety of Your Funds’.
If you’ve just started out or are exploring a forex trading career, thereare many choices of brokerage firms out there for you today. Yourobjective in this stage is probably to test the water. You could deposita couple of hundred or thousand dollars. This is a relatively smallamount of trading capital. However, when you progress with yourtrading career, tens of thousands or even hundreds of thousands ormillions dollars are large amounts of money, your most concern wouldbe the safety of your fund.
On the other front, some individual traders and trading firms areconcerned about minimizing tax expenses, they may choose to openaccounts with a particular country domiciled broker for the taxpurposes. At this point in time, U.K and Switzerland based brokers areprobably popluar choices because these countries are tax havens aswell 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, theRussian Federation, Costa Rica, might lack such well estabishedregulatory bodies. At this time of writing, some forex brokers settingup offices in Hong Kong and Singapore are on the rise to provideclients with better regulatory reputation and tax advantage.
Due to the recent collapses of large and well established financialgiants like Lehman Brothers (U.S.), Northern Rock (U.K), Kaupthing,Glitnir, Landsbanki (Iceland), and other smaller financial institutions allover the world, have had implications on other financial marketsincluding forex. One of the evidences is that, in October 2010, theNational Futures Association (NFA) in U.S. imposed new leverage ratesof 50:1 for major currency pairs and 20:1 to the cross ones from thestandard 100:1 to retail clients from all forex brokers domiciled inU.S., while brokers outside U.S. have no impact from the changes. Bysaying that, it doesn’t mean either a positive or negative news, itdepends on who looks at it! For a minority of winning traders it doesn’tmatter too much as there are always better opportunities arising fromthe changes, while the majority of losers keeps complaining about thechanges.
Successful traders consider their brokers as a risk point in their tradingsystems. So they understand the rules of the game and do everythingthey 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 Switzerlandwent bankrupt in May 2009; U.S. based Refico went bust inOctober 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 segregatedaccount from their firms’ ones only. In case of bankruptcy, yourfund would have a higher chance of being returned to you.
Secondly, going for brokers who are voluntarily registered with awell established regulatory body like NFA (National FuturesAssociations) and CFTC (Commodity Future & TradingCommission) both in U.S., or FSA (Financial ServicesAssociation) in U.K., or ASIC (Australian Securities andInvestments Commission) in Australia, or probably SFBC (SwissFederal Banking Commission) but be careful about Swiss basedbrokers! At least, these regulated brokers, by complying withthe regulations, file their regulatory standing on a regular basisand 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 aredone through central exchanges. For this very reason, there isplenty of room for frauds and scams to occur in the forexmarket. Like any other traditional businesses, frauds and scamsdo occur regardless of individuals or institutions involved, leveland credibility. Who would be in doubt that Bernard Madoff,once the chairman of reputable NASDAQ exchange in U.S, wasone of the biggest fraudsters on the individual as well asinstitution 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 acompany putting up a nice front office and a website with manyeye-catching stuff and claims, investing in infrastructure liketrading 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, rangingfrom dishonest practices in mixing your fund with their firm’sone, executing your orders at your disadvantage, re-quotes,’legally’ trading against their clients, back office manipulation; tolarger scales like ‘stealing’ millions or even billions of dollarsfrom investors or traders’ funds.
By saying that, it does not mean to be scared off or to stay awayfrom the forex market. Rather we understand them and takenecessary steps to minimize them. Frauds and scams arealways there in any market, not just the forex market.
In the sections that follow describe key factors that you may need toconsider when selecting your forex broker.
Safety of Your Funds:
Being a successful forex trader is a long-term journey and a life-timeachievement for most traders. On average, it takes 5 to 10 years torealize significant rewards for such a worthy pursuit.
In this game, it’s simply that ‘no capital no game’. So protection ofyour trading capitals should be of the highest priority. Do not letanother ‘Bernard Madoff’ steal your money! Below are somerecommended criteria for you to seriously consider before opening alive 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 firmsregistered with at least one of a well established regulatorybodies listed below. This will help you minimize the risksassociated with the unregulated market. These risks mayinclude firm bankruptcy, frauds and scams as mentioned above.
Up to date, there are five ‘trustworthy’ regulatory bodies for theforex market in the major financial centers in the world. Theyare:
- NFA (National Futures Association, website:-) in the United States of America.
- CFTC (Commodity Futures Trading Commission, website:-) in the United States ofAmerica.
- 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. Becareful for brokers only registered with the Swiss authorities! Switzerland is well-known for its reputation asone of the world’s major financial centers, especially inbanking. The problem is that some people have beenexploiting its lax financial market regulations for fraudsand scams.
You can check if a broker is registered with one of the regulatorybodies above by their ID or name. If yes, then you would seetheir registration information, name of principles, history ofcomplaints against the firm, so on.
Regarding complaints, there is a subtle discretion that needs tobe viewed in balance. Firms with larger number of clients aremore likely to have more complaints. So other factors like thefirm’ capitalization and client base need also to take intoconsideration.
Capitalization Of A Forex Brokerage Firm:
When a brokerage firm is registered with a regulatory body, thatfirm must meet a minimum requirement of capitalizationrequired by that regulatory body. At this time of writing, theminimum capitalization requirements from different regulatorybodies 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 ontheir clients. However, it does not mean your trading capital issurely protected.
Is Your Trading Capital Put In An Account SegregatedFrom Broker Firm’s Fund?
Only select forex brokers who put your trading capital in asegregated 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 clientname depending size of your trading capital and negotiation withthe broker.
The first protection of having such a segregated account is toprevent the brokerage firm from putting their hand in the fundfor 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 goesbankrupt. In U.K., according to FSA, client funds are protectedfrom the firm’s secured creditors or liquidators, so you will mostlikely get back your fund. In Switzerland, according to SFBC,your fund is treated as unsecured creditor, so you are the last onthe 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 ofclear description of hidden fees born by their clients for each method.
Now let’s look at hidden fees associated with each method of depositor withdrawal that some brokers out there have deliberately hid fromtheir clients or for whatever reasons.
The beauty of deposit from or withdrawal to credit card is that youcan do it online hence saving lots of your time. Also transaction iscompleted in the shortest timeframe. Fund appearing on your tradingaccount is usually within 24 hours since transaction; or max. 5business days for withdrawal. The drawback is that credit cardcompanies limits the max. amount of transaction at one time, typically2000 USD; and max. amount within a calendar month, typically10,000 USD. So if you like to transact 5,000 USD you have to do itthree times: 2000 USD, 2000 USD and 1000 USD.
When you deposit your fund into your trading account with a forexbroker, the credit card company charges you a percentage for service,usually ranging from 2% – 5%. For example, if you deposit 1000 USDthe credit card company will charge you 20 USD – 50 USD for service,hence you will see only 980 USD – 950 USD appearing on your tradingaccount.
Similarly, when you withdraw your fund from the trading account intoyour credit card, you will be charged a similar percentage for service.One way to avoid this charge is to have an ATM bank account linkedwith your credit card. The deposit will go into this ATM card instead ofthe credit card.
One notion that you may need to pay attention is that the exchangerate at the time of deposit or withdrawal is determined by your bank.This exchange rate may affect overall loss / profitability to your tradingbusiness.
Wiring transfer is probably the most popular method for deposit orwithdrawal.
Today wiring transfer can be done online hence saving lots of yourtime. Most banks charge you a fixed rate, typically 25 USD – 40 USDdepending on domestic or international transaction, regardless of thetransacted amount.
Some forex brokers accept deposits by check. It typically takes 5business days to clear the check. Also there is fee associated withcheck 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/withdrawalmethods offered by forex brokers today. They are usually safer thancredit card transaction. However, there also are fees associated withtransanctions from these payment service providers, so you have todig deeper into these fees before applying for these online moneyservices.
In the next article I will talk about the BROKER PRACTICES and others…stay tuned.
Experience luck everyday toward your fortune.