Forex Brokers - most important points to consider (2022)

Choosing a forex broker:

Forex trading continues to be extremely popular. With a daily volume of $5.1 trillion, forex is the largest and most liquid market in the world.

Even the largest debt market in the world, the US bond market, has a daily volume of “only” $456 billion.

This explains the tremendous interest in Forex trading and the large number of brokers. Where there’s brisk demand, there’s also brisk competition. Forex is no exception, but you often hear stories about dubious Forex brokers and customers suffering financial damages because of them.

In this article we’ll show you what you need to consider to minimize your risk of suffering financial damages due to your forex broker.

What you need to consider when choosing a Forex broker.

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The company running your forex brokerage

It is extremely important to know exactly what company is behind the forex brokerage. As with a long-term investment in stock, you should only choose a strong company to place your money with.

Strong financial position and balance sheet

A strong financial position and balance sheet are important to ensure that the forex broker you choose can continue to operate even in difficult economic times. It’s a good sign if the broker has experienced crises and was able to survive them.

For forex trading, a good example is the “flash crash” of the Swiss franc in 2015, when the Swiss National Bank (SNB) stopped supporting EUR/CHF at 1.20 and at the same time lowered its deposit rate from 0.5 to –0.75%.

This led to an extreme price drop. On January 15, 2015, EUR/CHF plummeted by 30% to 0.842. Because this move was so violent, the stop losses that many Forex traders had placed in the market were triggered with a delay. The reason is that, when a stop order is placed, it’s only executed at the next available price. As a rule, this isn’t a problem, but it can become one in extreme events such as a crash. Due to the high leverage used, many accounts went into the red within minutes. A large number of investors had to add money to their accounts because the positions could not be closed in time.

Because the SNB had been supporting EUR/CHF at 1.20, there were initially no quotes in interbank trading below this price level, and the lack of liquidity led to extreme swings.

However, many financially sound brokers were able to handle the losses.

One exception was the broker Alpari, which had to file for bankruptcy because its losses exceeded its liquid assets. FXCM and Saxo Bank also suffered extremely high losses relative to their liquid assets, but ultimately survived.

The forex broker Plus500 is even said to have recorded a profit. In my opinion, Plus500 should have kept this information to itself, because it suggests that a large number of trades were not hedged. In other words, the clients’ losses were the brokers’ profits. With 95% of clients not making money in the long run, a forex broker can run a profitable business this way. However, in my view, it’s brokers like these that should be avoided.

A capital adequacy ratio (CAR) that remains nearly unchanged after a black day in the forex market is a good indication that a company will be able to survive future turmoil in the global financial markets. The CAR of JFD Brokers (now JFD Bank), for example, remained constant at 24.5%.

The greater the financial stability and stronger the balance sheet, the greater the chance that a broker will survive difficult times.

This was also the case with Interactive Brokers. The losses inflicted by the flash crash represented just 2.5% of its financial assets. Due to its great financial strength, IB emerged nearly unscathed.

History and credit rating

It’s also important to know how long a company or a broker has been in business. The longer, the better, as it shows that the company has survived any number of difficult economic times. After all, only in crises and extreme situations can you see whether a company or broker is well positioned.

It is also advantageous if the company running the brokerage has a good credit rating. However, very few of these companies have credit ratings at all. You should also bear in mind that a good rating can be acquired in a manipulative fashion.

Investor and account protection

This relates to how you as an investor and your account are protected against unforeseeable risks.

Negative balance protection policy

This is another critical point. With this policy, the broker largely waives the requirement that customers must add money to their accounts. Simply put, this means that the broker covers the customers’ negative account balances with its own funds. Automated risk management systems are used to prevent negative account balances.

Two examples are Admiral Markets and Oanda, which covered negative account balances with their own funds.

In the past, IG Markets waived 90% of the margin requirement for customers, but the remaining 10% nevertheless represented a large sum, especially for customers who used high leverage.

Extreme situations always provide an opportunity to look behind the facade of a brokerage. After all, a lot of money is at stake here and, as we all know, that’s when there’s greater potential for conflict.

Company liquidation

Funds should be held separately for the exclusive benefit of customers in the event that the company faces liquidation.

Customer reserve obligations should be calculated as frequently as possible. The industry standard is to perform these calculations on a weekly or monthly basis, but some brokers do so every day.

If calculations are performed on a daily basis, it provides greater protection for the funds deposited by the customer. The reason is that, as a rule, brokers only protect what was on deposit during the last computation.

In the event of insolvency, this practice also makes it possible to identify customers more quickly. Lehman Brothers is a good example of how long it can take to repay assets if there is no daily calculation.

Real-time risk margin calculations

The risk margin requirement should be calculated in real time for all customer accounts. However, the majority of brokers calculate it on an end-of-day basis.

If it isn’t calculated in real time, the account may later be liquidated due to insufficient collateral. This increases risk.

The broker should carry out liquidations in real time in order to return the account to margin compliance as quickly as possible.

Customer funds segregated from company capital

Customer funds should be segregated from company capital so that they are not affected in the event of bankruptcy. They should only be held with the most secure financial institutions. In addition, accounts should be protected by deposit insurance. This means that if a forex broker is unable to return customer deposits, repayment claims are covered up to a specific amount by the deposit insurance program.

Separation of brokerage and market-making activities

Brokerage and market-making activities should be carried out by separate companies, both of which should be registered with the local regulatory authorities. There should be a strict separation of the systems and processes in both of these businesses.

Brokers shouldn’t trade for their own accounts

The brokerage should only act as an intermediary for its customers’ trading activities and shouldn’t enter into speculative trades of its own. Lehman Brothers once again provides a good negative example, as does MF Global. In both cases, bankruptcy was caused by the risks of proprietary positions.

Login security and confidentiality

Your account and assets should be protected by a secure login system. This means that even if hackers have attained your username and password, they won’t be able to log in to your account because they don’t have physical access to a security device.

Brokers should also guarantee that they keep personal data confidential and secure at all times.

Regulation and licensing

The broker should be registered and licensed and should comply with strict European financial regulations:

MiFID
BaFin
FCA
CySEC

In addition, the broker should be a member of the Investor Compensation Fund (ICF) or the Securities Investor Protection Corporation (SIPC). In this case, customers can file a claim with the respective institution if the broker is no longer able to meet its financial obligations. This provides additional protection for deposits.

Awards

Awards are generally a positive, but you shouldn’t place too much emphasis on them because other factors are more important. Although awards can never hurt, you should keep in mind that they can be obtained in a manipulative fashion.

Pricing and order execution

Order execution, spreads, slippage, and transaction costs

This is another important aspect of forex trading. Order execution should be fast and fair. Spreads should be reasonable. Many brokers advertise low transaction costs, but then widen the spreads.

Another important factor is slippage, which we explain in greater detail here.

DMA/STP forex brokers

The broker should offer straight through processing (STP) or direct market access (DMA) to a variety of liquidity providers. These systems let you trade directly with leading liquidity providers such as banks, non-banks, and multilateral trading facilities (MTFs). As a result, you obtain the best possible price at any time. Orders are routed directly to the liquidity pool via a bridge. In a pure STP system, orders are executed on a fill or fill basis, which means they are never rejected. You can also benefit from improved prices and positive slippage.

DMA/STP offers the following advantages:

No discriminatory rules
No re-quotes
Direct access to the best bid/ask
No conflict of interest
Complete transparency

If a Forex brokerage claims to be a DMA/STP broker, make sure it can back up this claim by providing a trade execution report and meeting all post-trade transparency requirements.

Summary

Unfortunately, there are a lot of black sheep in the brokerage industry, but you can usually spot them quickly and easily. Often first impressions are enough. It’s often a bad sign if the broker’s marketing policy is overly aggressive or the broker uses celebrities in its ads.

In addition, I would generally avoid brokers that offer binary options. They would be the first I’d strike from my list.

If a broker is run by a sound company that has survived several crises and is regulated and licensed, it’s a good place to start.

In addition, if the broker offers DMA/STP and can back up its claims – and if it provides the opportunity to trade the forex spot market in addition to pure CFDs – then it is certainly recommendable.

Introduction of forex brokers, test, and reviews

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