The coming of the internet and now the onset of the recession has caused a greatly increased level of interest in fx online trading. New brokerage web sites are springing up all the time and it’s difficult to decide which one to opt for. But whatever you decide, here are 3 questions you must ask your broker before you open an account.
1. Are you an FCM (Futures Commission Merchant) broker or an ECN (Electronic Communication) broker?
The trouble with FCM brokers is that very often they have their own dealing rooms and tend not to pass on their customers’ trades to the actual fx market. They match one customer with another, or alternatively bet against them. With all their facilities and the ability to manipulate the prices on their system, it’s no surprise that they usually profit at the expense of their customer-traders.
By way of contrast, ECN brokers don’t have their own dealing rooms, but pass on all trades to the market, as they should. They therefore cannot bet against you, but simply collect the “spread”, whether your trade is profitable or not. In addition, they have no restrictions on trading or hedging, and tend to have the best prices and spreads.
2. Where are you registered and how much is your capital?
Avoid any broker who is registered in an offshore jurisdiction. If he is then you may have problems if you decide to withdraw your money. He should be registered in the US, the UK, a major European country, Australia or Japan, with the appropriate regulating authority. In the UK it’s the Financial Services Authority and in the USA it’s both the US Commodity Futures Trading Commission and the National Futures Association. Ensure the company’s capital is at least $7 million (USD), or £5 million (GBP). This keeps to a minimum the danger it could go bust and take your money with it.
3. Can I trade with covered warrants and ETFs (Exchange Traded Funds) as well as spread bets?
A spread betting account is the most profitable account for the broker, so that’s what he will recommend to you. But there are other methods of trading fx which can, once you master them (which is not difficult), be far more profitable for you.
When you make a spread bet on a currency pairing, for example the British pound and the US dollar (GBP/USD), there will be a “spread” that you have to overcome before you get into profit. This is how the broker makes his money.
So, for example, as I write, the GBP/USD pair are trading at 1.6257. If your currency trading account has a 3 point spread your broker may set his buy/sell prices at 1.6256/1.6259, so you can go long (buy) at 1.6259, but the price would have to move up 3 points to 1.6260 (1.6262/1.6259) before you would be at “break even” point. The same applies in reverse if you choose to sell, or go short. You are always at a disadvantage compared to the market or your broker.
Spread betting with absurdly low “stop loss” levels makes it almost impossible for the new trader to avoid losing all his money very quickly. The small amount of capital required by most brokers to open an account, which is presented as being generous on their part, enabling the “ordinary Joe” to “open a currency trading account and start profiting”, actually works against you.
Each trade becomes a major risk to your entire capital, and you can only trade with tight stop loss levels. In the volatile fx market, where prices move erratically and seldom go up or down in a straight line, this is crazy. The few successful traders in this market employ large stop loss levels, even on trades they are very sure about. This enables them to ride the volatility of the market.
The only solution is to avoid spread betting altogether, in your fx online trading, and instead use covered warrants and Exchange Traded Funds. Hence this question. You may, however, have to go further than your broker in order to learn how to trade these instruments.
Philip Gegan
