Three key considerations before you start forex trading
Choosing the right forex broker is critical, says Compare Forex Brokers’ Justin Grossbard
The US election and Covid-19 have increased the amount of interest in trading forex markets, and choosing the right broker is critical.
Justin Grossbard from compareforexbrokers.com provides three key criteria to consider when choosing a forex broker.
Types of brokers: dealing desk vs no dealing desk?
When trading forex there are many variations of brokers and execution models that retail traders can choose from. The largest distinction between types of brokers is dealing desk vs no dealing desk (NDD) execution.
Dealing desk brokers are market makers that act as the counterparty to a trader’s order. Using a dealing desk, market maker brokers set their own bid/ask prices and fill orders with their own internal liquidity.
Brokers that execute trades with NDD include straight-through processing (STP), electronic communications network (ECN) and direct market access (DMA) business models.
STP and ECN brokers both match clients’ orders with external liquidity providers, yet STP brokers have control over their liquidity sources and ECN brokers do not. DMA provides direct access to markets, allowing traders to view all the current prices available from multiple sources.
While many brokers are pure market makers or ECN brokers, hybrids of two or more execution models are increasingly common. Similarly, brokers often offer a range of account types with different pricing and execution, such as ECN, DMA and commission-free accounts.
Spreads and costs: commission vs no-commission accounts?
Two common pricing structures and account types are available for retail forex trading that suit different levels of experience and styles of trading.
The big cost of trading forex is the spread, being the difference between a forex pairs bid/ask prices. Traders look for tight spreads, where the difference is narrow.
The second trading cost is commission, with brokers receiving compensation for their services in two ways. Some include compensation in their spreads with no additional commission fees charged on top of the spread. Other brokers offer tighter spreads while charging volume-based, flat-rate commission fees.
The spreads and fees brokers charge largely depend on its execution model. Market makers such as Swissquote set their own spreads and do not charge any additional commission fees on top of the spread, yet spreads are significantly wider. Conversely, Financial Sector Conduct Authority (FSCA) regulated market maker Markets.com determines their spreads based on STP models, ensuring spreads are in line with NDD brokers.
No-commission trading is not exclusive to market makers, with many NDD brokers offering standard accounts with no commission fees. Beginner traders are well suited to commission-free accounts as they provide a simple pricing structure with no requirement for complex fee calculations.
NDD brokers such as Pepperstone and IC Markets offer commission accounts that provide access to institutional grade spreads as tight as 0.0 pips while charging low-commission fees. As NDD brokers connect clients to multiple liquidity sources, traders can access the best bid-ask prices available in forex markets. Commission accounts with the tightest spreads and the lowest commission fees, such as Pepperstone and IC Markets, are ideal for experienced traders developing scalping, day trading or algorithmic trading strategies.
Regulation: local or offshore regulated brokers?
SA’s FSCA, among other top-tier financial authorities, have issued warnings about the rise of forex scams triggered by Covid-19. The announcements stress the importance of understanding the investor protection traders receive from top-tier financial authorities, along with the high risk that comes with using unregulated brokers.
Trading with an FSCA-regulated broker provides benefits and protections to SA forex traders. The FSCA requires licensed brokers to treat their traders in good faith, provide quality forex education, and protect trading account balances by segregating client funds from operational capital.
The FSCA does not restrict SA traders to local brokers, however traders should be cautious when choosing an offshore broker. Though brokers licensed by offshore regulators (ie IFSC) can offer absurdly high leverage up to 3000:1, traders receive minimal protection and expose themselves to significant risk. The highest risk comes from trading with an unregulated broker, due to the likelihood of scams and no investor protections or safeguards from financial authorities.
Rather than an FSCA-regulated broker, SA traders have the option of using a broker from a major financial hub such as Australia or the UK. There are many highly regulated brokers that cater to the international community, with Pepperstone and IC Markets being popular options among both beginner and experienced traders.
While tight spreads and low commission fees are important factors when trading forex, regulation and investor protections are gaining weight as unprecedented global events unfold. Whether you are looking for simple no-commission spreads, or an experienced trader after tight ECN pricing, choosing an FSCA or top-tier regulated broker will provide the best trading experience while reducing the high risk of trading.
This article was paid for by Compare Forex Brokers.