Choosing A Forex Broker
All forex traders need a broker. We have talked in earlier sections about some of the services that brokers will provide when you sign up for a trading account, and we have made it clear that in the beginning you should only be operating a demo account.
Demo accounts are free. Brokers give them away because they know that 90% of the time, when you start trading for real you will want to use the platform that you are already familiar with. This means that you should choose your broker carefully before you even sign up for the demo. You could switch later but it will be easier if you make the right choice now, and to do that, you need to act as if you were going to open a real money account right away.
So when you are choosing a forex broker and before you sign up with anybody, there are a few things that you need to know.
Types Of Forex Broker
There are several types of forex broker and people new to currency trading may be surprised to find that some companies offering forex trading services are not brokers in the traditional sense at all.
Traditionally a broker would work for you as a client, placing your buy and sell orders for you through their dealing desk and charging commission (for stock exchange transactions) or making their money from the spread (the difference between bid and ask prices) for forex trading. At one time orders would be placed by telephone. Now they are placed online, with you in full control of your account.
But standard forex accounts run on these lines require significant investment. Typically the minimum deposit for a standard account could be anything from $10,000 to $50,000. Of course, now that forex trading can be done from home, there are many new services springing up with lower deposit requirements, offering forex mini accounts where you can start with $1,000 or less. But the business model of these new services is not necessarily the same as traditional brokers, and this can have implications for you.
There are 4 main types of broker.
- NDD Brokers (No Dealing Desk)
Brokers without a dealing desk communicate with external liquidity providers to provide prices and match your trades. Because there is a range of liquidity providers, the original spread tends to be small but the brokers may increase it to give themselves a reasonable profit margin.
- ECN Brokers (Electronic Communications Network)
ECN brokers provide a marketplace used by banks, market makers and regular traders. Trades will be entered in the name of your ECN provider for anonymity. Spread is generally small but the ECN will often charge a matching fee per trade.
- Market Makers
When you have an account with a market maker, your trades are not being matched by external providers but by the market maker themselves. This means that they take the opposite position and offer their prices to you, although of course these prices relate to the current price in the market. They will then offset their risk by taking an equivalent position to yours in an ECN or other environment.
Since they are not actually placing your order in the market, market makers are not brokers in the true sense of the word although most traders use the term forex broker loosely and include them. Others consider that the difference between market makers and bucket shops is not clear and prefer to avoid them.
- Bucket Shops
Bucket shops work a little like market makers but they do not offset their risk and may have very little connection to the real spot forex market. When you deal with a bucket shop you could be said to be betting against them. They oppose your trade and they profit by your loss. Like commercial bet takers, if you are consistently successful they tend not to want your business and will probably close your account, returning your funds to you. A bucket shop is working against you, not for you.
They are illegal in some jurisdictions and they are best avoided, certainly for beginners.
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