In order to successfully trade Forex you need a good broker. However, as a beginner it is often difficult to choose the right type of FX broker. There are several types of brokers and you need to know about each type in order to make an informed decision on which to choose.
Unfortunately, the Forex market is a bit like the “Wild West”. Unlike the stock market which is highly regulated and is traded on a specific exchange like the New York Stock Exchange (NYSE) or the NASDAQ or the London or Vancouver Stock Exchange, FOREX transactions take place electronically between agreeable buyers and sellers from all over the world. Theoretically, this gives you a large pool of potential people to take the other side of any transaction but since this network is not centralized, the exchange rate of any currency pair can vary from one broker to another. So this is another reason to be careful when choosing a broker.
1) Interbank Market-
Just as it sounds the Interbank market is the market for currency exchange between the big banks. Retail traders are unable to trade FOREX on the interbank market it is reserved for the biggest banks. However, if you wire money to a foreign country to be deposited in another currency or travel to a foreign country and buy something on a credit card your money will be converted via the Interbank market. So if you want to trade Forex you will need to choose either an “ECN” or a “Market Maker”.
2) Electronic Communication Network (ECN)-
An ECN is simply an electronic bridge that links small market participants through an ECN broker to tier-1 liquidity providers (i.e. the Interbank Market). The broker obtains liquidity from tier-1 liquidity providers (Major Banks) and makes it available for trading to its clients. On the other side, the broker delivers clients’ orders to Liquidity Providers for execution. This link is created through a sophisticated technology called FIX Protocol (Financial Information Exchange Protocol). An ECN broker benefits by charging commissions on each transaction. Obviously, the higher the trading volume, the more the broker makes.
On an ECN, traders have direct access to the market. Market prices and the bid/ask spread fluctuates reflecting supply and demand, volatility and other conditions. Since the ECN does not control the bid/offer spread it can fluctuate between 1 pip and many pips based on market conditions.
3) Market Makers
In the stock market, “market makers” help to create liquidity by offering to both buy and sell a particular stock. In other words, if at any given moment no one is selling the market maker will sell shares from his inventory and buy them back later from someone else who is selling and put them back in his inventory. In normal markets, a market maker aims to make money by taking advantage of the difference between “bid” and “offer” prices. On the London Stock Exchange for instance one can always buy and sell stock because each stock always has at least two market makers who are obliged to deal at all times, in exchange for certain trading advantages.
The Forex market is not as regulated as the stock market however and often “market makers” don’t have any access to the real Forex market. Good market makers should be minimizing their risks by contracting with larger market makers or brokers so that their clients can be redirected to the interbank market when needed. They usually provide their clients with the latest trading tools such as MetaTrader 4, allow you to trade a demo account and usually have a fixed spread between bid and ask.
How to Choose?
Some of the must-have features of FX brokers are listed below. Go through them and figure out ways to select the best services for yourself:
- They should have excellent customer services. If you want to get through to them regarding any concern they should be available either online or on the phone. If not seek different brokers.
- They should have sound technological back up to be online 24*7 so as not to miss out on profitable trading opportunities. The fast paced volatile market has witnessed several platform crashes and you definitely don’t want to be at the receiving end in this regard.
An ideal Forex broker should be chosen after considering factors. Ask your experienced trader friends to chip in with due suggestions as well.
Risk Warning: Trading forex or CFDs on margin on the OTC market carries a high level of risk and may not be suitable for all investors. There is a possibility that you may lose all of your initial investments
Author Bio: Sam Payn’s experience as a financial blogger has made him one of the most sought after writers today. At present he is writing about Forex and loans.
Image courtesy of Stuart Miles / FreeDigitalPhotos.net.
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