Saturday, June 24, 2017

Why Do Currency Traders Need Forex Brokers

forex broker illustrationLight years ago, in a galaxy far, far away…. financial institutions, banks and international monetary funds were the only participants in the trading of foreign exchange instruments.

Thats a fancy way of saying forex!

Forex brokers at the retail level did not exist because these institutions monopolized the foreign exchange due to their abilities to have access to information and data that allowed them to hedge their interests and profit from the monetary policy that the average investor could not get to very easily. This, combined with government regulations and the huge volume required in trades to maintain adequate liquidity,  prohibited the small speculator from participating.

Access to the currency markets changed however, first with the invention of the internet… this new and exciting information super highway opened the doors to allow anyone virtually instant access to the same macro-economic events, news and data that the large world banking institutions had previously dominated. Combine this new fangled world wide web with legislation by the CFTC and we soon found ourselves with a retail market for individual traders to have the same abilities to trade currencies as the big boys.

What Are The Differences Between Brokers?

In order to access the forex as a retail trader, we need brokers to provide us with a platform to trade from, liquidity and reliable execution of our trades. Much like a stock broker, the forex broker acts as  an intermediary for these ( relatively speaking) small trades, and they also can assist in advice, recommendations etc. Each brokerage house can have different commission rates, minimum balances and account requirements that make it essential for any forex trader to research and become familiar with before opening an account.

Before selecting a brokerage firm, it’s important to understand the basic differences from one to the other, and also to have a good understanding of what your choices are. Forex brokers, for the most part, fall into one of two categories. There are Market Makers, also referred to as “Dealing Desks” and there are Straight Through Processing Brokers (STP), also referred to as “Non Dealing Desks”.

Market makers provide the liquidity for a given currency market themselves, and they make their money off of the spreads, (the difference between the bid and the ask) and by placing hedges, or bets against their customers. In other words, when you place a trade with a Market Maker, more then likely, they will be taking the other side of that trade in the expectation that you will lose. So…. the market maker earns money through both the spread and by hedging your bet. It seems a bit counterintuitive doesn’t it? But this is how it works… your trades are commission free, but the spreads tend to be a little wider.

Straight through processing brokers, or non dealing desks, do not create their own markets… meaning that they do not take the other side of your trade. Your order is sent straight to the recipient on the other side of your position. These brokers however, do charge commissions for each trade you place with the advantage to you being a tighter spread.

Do Your Research First

Which type of broker you choose is dependent on what type of trading you do. If you are a day trader and a scalper, then it will probably be better for you to enjoy tighter spreads and just pay the transaction fee because you are attempting to make a profit with a smaller expected move by virtue of the very short time frame with this style of trading.

Conversely, if you are a swing or a position trader, holding onto a position for days, weeks or maybe even months, then the spread is of less consequence to you because your expected move will easily overcome this.

Knowing what type of trading you will be doing is a big part of choosing which type of brokerage house is best for you, but it’s most certainly not the only research you need to do when looking at different forex brokers. You also need to be aware of fraudulent enterprises know as “bucket shops”. Bucket shops are essentially fake brokers that work out of boiler rooms acting as legitimate forex brokers. They man the phones… take your orders and then promptly drop it in a bucket, hence the name. Simply being aware that these types of scams exist should be enough to insure that you do proper research and due diligence before transferring funds to anyone.

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