For the individual who wants to try his/her hand and swapping currencies, known as retail forex trading, all that’s required is any device that will supply reliable high-speed Internet access, trading software and a forex broker.
This article will concentrate on the forex broker factor of the equation and offer guidance for choosing a broker to match a trader’s experience level and personal preferences.
There are two predominant types of brokers. One is the Electronic Clearing Network (ECN) broker and the other is the Market Maker broker.
In the interest of objectivity, no brokers will be specifically named, no recommendations will be provided and no website addresses or other broker contact information will be supplied.
This attempt at neutrality is also intended to make you aware of one critical aspect of forex trading: Forex trading at the retail level is essentially a solitary activity. Do your own research, make your own decisions, then accept the responsibility for your decisions and actions. Avoid like the plague any and all self-proclaimed gurus and their claims of trading systems and analysis techniques that produce spectacular profits. Trading is a competition. It’s you against everybody else. If you had a foolproof system for winning 90% of the time and raking in fabulous profits, would you sell it to me? I wouldn’t sell it to you, yet a lot of people, okay, a couple people, think I’m a swell guy.
Electronic Clearing Network (ECN) Brokers
To rapidly understand the primary difference between the market maker and the ECN and broker, all you need to know is that if you enter a long or short trade order, the market maker will immediately become the counter party to your trade and your order will be filled. You’re actually competing against your broker.
An ECN, on the other hand, requires that another counter order exists for your order to be executed. The ECN broker is neutral in the transaction.
What exactly, does this mean?
Not much, when you come right down to it.
There is a theoretical possibility that it might take additional nanoseconds for your order to get filled by an ECN broker, but considering the trading volume, number of traders approaching the same data from different perspectives and the staggering amount of money rapidly changing hands, this possibility that your order will remain unfilled is infinitesimal, particularly if you concentrate on the major currency pairs.
There are far more practical considerations that come into play.
Practical Benefits of ECN Brokers
1. No manipulation of the order book – ECNs are simply trade matchers – not participants.
2. Much less probability of foul deeds – stop harvesting, inflating the bid/ask spreads and quoting prices that vary from reality.
3. Tighter bid/ask spreads.
Disadvantages of ECN Brokers
1. Larger initial account size, beginning around $2500 and up.
2. Larger minimum trade size requirements, typically 10,000 units of the currency pair.
I would interject the competition for new traders among brokers is fierce beyond belief.
That’s because the forex market continuously needs new traders to replace the ones that lost all their money and have to quit trading. Don’t be discouraged by this. Without somebody losing money, there would be no market and no opportunity to make money.
I spoke with a customer-service representative of one of the world’s largest ECNs. When I inquired about the minimum account size, she replied, “$2500 is recommended to begin.” Almost before the sound waves from that utterance subsided, however, she said, “We may be able to get you started for around $1000.”
It’s really a buyers market for retail forex customers shopping for a broker. If broker A offers you a benefit that you consider important, but broker B, who you might actually prefer for one or more other benefits does not, go ahead and ask for broker A’s benefit from broker B. The worst they can say is no. If they say yes, get it in some form of writing.
Don’t try this if you’re afraid that you might make the representative mad or that they won’t like you. If you want to be well thought of and make friends at all costs, forex trading might not be your forte’. All’s fair in love, war and forex trading. If you’re after friends and respect, concentrate on Facebook, do volunteer work or donate money or blood to a worthy cause.
Practical Benefits of Market Maker Brokers
1. Accounts can be opened for as little as one dollar.
Practically speaking, you will need about $300 to trade micro lots of 1000 currency units to allow you enough leeway to defend a trade. Defending a trade simply means entering a trade for a larger number of units in the same direction, long or short, when the initial trade moves against you. Doing this brings your average price closer to the market, increasing the probability that a small correction of prices in your favor will provide an opportunity to minimize the loss or even exit with a profit.
2. Slightly better liquidity.
Since the market maker acts as the counter party to your trade, your order will usually be filled at very close to your desired price. This is more significant if you take complete leave of your senses and try to trade some bizarre pair like the United States dollar/Czech Republic koruna (USD/CZK), but if the typical 500 bid/ask spread is not enough to deter you, no advice I can offer will suffice to prolong your career as a forex trader.
3. Very small minimum trade size.
A micro account usually specifies that 1000 units is the minimum trade size, but many market maker brokers accept what are called “odd lots,” orders below 1000 units. My market maker broker accepts order sizes of 50 and 100 units, meaning that on a pair like the euro/dollar (EUR/USD) it takes two pips in the first case and one pip in the second to change my account balance by one cent. This is wonderful for testing new and unproven strategies. It’s also a great way to see how you respond physically and mentally to the information the market presents. You could consider these small trades as training, in the sense that an athlete, a weightlifter for instance, warms up with lighter weights before going for a personal best.
Drawbacks to Market Maker Brokers
1. Reputation for stop harvesting
Stop harvesting occurs, without a doubt. More often so in the earlier days of forex trading when there was zero regulatory oversight of forex brokers. Simply explained, market makers do not have to offer their customers the exact same currency pair prices that the big inter- bank players are trading from. In fact, if you read the terms and conditions and legal disclaimer documents brokers insist be signed before trading can commence, most of them freely admit this fact.
Stop harvesting takes place when the broker manipulates prices that cause your protective stop loss to be triggered, causing you to lose money.
It is fairly simple to avoid. How this is done will be addressed in the conclusion to this market maker brokers section.
2. Ballooning spreads
This term very accurately describes the practice by an unscrupulous market maker broker of increasing the bid/ask spread of an active trade. Just as a balloon expands as it is blown up, the spread will expand, making it necessary to stay in a trade longer in order to cover the spread and enter profitable territory. This extra time spent in a trade increases the possibility that prices may reverse against the trader, causing the trader to lose. The broker not only takes the trader’s trading equity, but also receives an increased fee.
3. Re-quoting prices
Even reputable market makers acknowledge that they may not offer their clients the best available currency rates. This admission is disclosed in the terms and conditions of the broker/client agreement. What makes this a major problem is when the broker’s price data stream quotes one price, but orders are executed at a different price, one disadvantageous to the client. Some of the governmental regulatory efforts directed toward the forex industry are intended to eliminate this despicable tactic and more regulation is on the way.
If you should decide that you want to test the forex waters by trading with a market maker, there are simple measures to avoid scam brokerage firms.
Consider having micro accounts with three brokers. Depositing $100 with each one will permit you to trade around 1300 currency units of the EUR/USD with each broker. By trading in odd lots of 100 units, each pip will equal one cent.
This tactic will permit you to observe the three different price data streams and watch for significant discrepancies in the price quotes.
You can also see which broker is offering the tightest bid/ask spreads.
If one of the broker’s price streams frequently results in price spikes that stop you out of a trade, but the other two brokers’ prices never hit your loss limit, chances are good that the broker is harvesting your stops.
This protective measure can be enhanced by getting a demo account with an ECN, so that you can compare prices between an order matching funding source and the counter party market maker types of brokers.
There are definitely reputable market makers. Do some basic research, visit some broker review websites, contact the brokers to gain a sense of their customer service and take advantage of the free simulated trading accounts they all provide.
If you find a market maker with competitive spreads, prices very close to the data stream of the ECN and support representatives that seemed genuinely interested in timely responses to your questions, then you have identified a solid market maker broker.
The choice of an ECN broker or a market maker broker eventually comes down to a question of how much money you have available with which to make your initial account funding deposit.
If you just want to see how you respond to trading forex as a supplemental or primary income producing opportunity and you’re willing to exercise proper diligence in the broker investigation process, you can choose one or more market makers that have excellent records for fair dealing and providing decent customer service.
If some of the negatives associated with market makers create anxiety for you, go with an ECN, provided your are comfortable with the initial deposit.
Don’t put undue pressure on yourself to make a perfect decision. Chances are good that if you adapt mentally and emotionally to forex trading and survive for any length of time, you will have ample opportunities to sample different brokers. Things change, and a broker that is an excellent fit today might enact policies that make that broker seem less so tomorrow.