The quality of FOREX brokers runs the gamut: some are honest and genuinely helpful; others trade against you or even resort to outright theft. It is incumbent on all new traders to carefully select their brokers and monitor their actions closely. Fortunately, there are a few steps you can take to increase the odds of getting best results from your broker. Always use a regulated FOREX broker.
There are two major types of FOREX brokers: those who trade against their customers (dealing desks or DD) and those that don’t (non-dealing desks or NDD). Why would a trader even consider using a DD broker? Its often a question of funds: you can establish a DD brokerage account for less money, and can often receive much higher margin ratios – the higher the ratio, the less collateral you have to deposit. If you have limited funds, one strategy is to establish one account of each type. If the DD price spreads or commissions are very different from those of NDD brokers, keep shopping.
NDD brokers come in two flavors: straight-through processing (STP) and electronic communications network (ECN). Both connect your trading orders in real time to the FOREX interbank market, where the big banks trade. STP brokerage involves passing your order to one of the big banks, which acts as counterparty to your trade. An ECN broker offers STP service, but also provides a real-time marketplace where non-bank traders can be counterparties to your trades. Both can earn commissions, but an STP-only broker can also make money by increasing bid/ask spreads. Either type is a good choice, but ECN brokers offer one decisive advantage – access to real-time market depth information.
Depth of Market Window
It is a good strategy to learn how to exploit the information available from an ECN broker’s depth of market window. This window is a screen that shows the volume of all pending bid and ask prices for each pair of foreign currencies. The taller the stack of pending orders clustering around the last traded price, the smaller the bid-ask spread. By analyzing spread information, you can strategically time your trades so that you pay a minimal spread – on the order of 1/100 of a percentage point, known as a “pip.” During busy hours, major currency pairs such as euro/U.S. dollar can trade essentially spread-free, whereas the spread may climb to 6 pips during quiet times.
Hide Your Intentions
If you do use a DD broker, the last thing you want to do is signal your intentions to close out a position – the broker can use that information to manipulate prices against you. For instance, if you issue a stop-loss order (an order to close out a losing position when current prices hit the stop-loss price) at a price five percent below the last trade and then prices start declining, a DD broker may “anticipate” your stop-loss price by quoting it as the current price, locking in your loss. You should always trade with a stop-loss in mind, but don’t tell your broker in advance. Instead, consider implementing virtual stop-losses with computer software: the online program continually monitors FOREX prices, and if your stop-loss price is hit, it immediately issues the trade order to liquidate the position.