Since I've received such an overwhelming amount
of emails from readers requesting for more information
on broker selection, I've decided to put together
a small comparison of the two types of brokers out
there. I hope you will find this useful, and if
you have any comments or suggestions, feel free
to contact me.
As you may already know, foreign
exchange (Forex/FX) is an unregulated market that
is not traded on an exchange, which means that prices
you see and get from one broker could vary from
those of another broker.
There are mainly two types of
brokers. One type is an ECN (Electronic Communication
Network) and another a Market-Maker.
Market-makers "make" or set the prices on their
systems based on what they think is best for themselves
as the counter-party. This is because every time
you sell, they must buy, and when you buy, they
must sell to you.
This is why they can give you
a fixed spread since they are setting both the bid
and the ask price. Many of them will then try to
"hedge" or "cover" your order by passing it on to
someone else; however, some may decide to hold your
order, and thus trade against you. This can result
in a conflict of interest between the retail trader
(you) and the market-maker.
ECNs, on the other hand, pass on prices from several
banks and market-makers, as well as from the other
traders in the ECN, and display the best bid/ask
prices based on these input. This is why sometimes
you can get
no spread on ECNs, especially in very liquid currency
pairs. How do ECNs make money then? They do so by
charging you a fixed commission for each transaction.
Here are some of the pros and cons of ECNs
and market-makers:
Market-Makers
Pros:
* Usually give free charting software and
news feed
* Prices can be "smoother"
and less volatile than ECN prices (this can be a
con if you are scalping or trading very short term)
* Often have a more user-friendly
trading and analysis interface
Cons:
* They may trade against you. In that case,
there will be a conflict of interest between you
and them
* The price they offer you
may be worse than what you could get on an ECN
* It is possible that they
may trigger stops or not let your trade reach your
profit target levels by manipulating prices
* During news, there will
usually be a large amount of slippage; their systems
may also lock up or not allow order placing during
times of high volatility
* Many of them discourage
scalping and put scalpers on "manual execution"
which means their orders may not get filled at the
price they want
Examples of some market-makers:
http://www.ac-markets.com
http://www.oanda.com
http://www.gftforex.com
http://www.fxdd.com
http://www.cms-forex.com
ECNs
Pros:
* You can usually get better bid/ask prices
since they come from several sources
* Variable spreads between
bid and ask may give no spread or tiny spreads at
times
* If they are a true ECN,
they will not be trading against you but will pass
on your orders to a bank or another customer on
the other end of the transaction.
* You will be able to offer
a price between the bid and ask with a chance of
it getting filled
* If they support Stop-Limit
orders, you can prevent slippage during news by
making sure that your order either gets filled at
the price you want or not at all
* Prices may be more volatile
which will be better for scalping
Cons:
* Many do not offer integrated charting
* Many do not offer integrated
news
* Many of the trading platforms
are less user-friendly
* Because of variable spreads
(between bid and ask,) it may be more difficult
to calculate stop loss and profit target in pips
beforehand.
Examples of some ECNs*:
http://www.mbtrading.com
http://www.hotspotfx.com
http://www.interactivebrokers.com
http://www.fxcm.com
(note: FXCM told me that they
now offer a "No Dealing Desk" execution option,
and they are no longer a market maker)
* Some of these "ECNs" may not be true ECNs,
and you may be going through a dealing desk.
It is impossible to verify for sure because of the
lack of regulation governing forex brokers.
Just because they say they are an ECN, doesn't make
it true.
The industry needs to enforce better “truth in
advertising” laws, and we’re seeing that more
and more. You can’t pretend that you aren’t a
dealing desk just because people like to hear
you say that, but then make your money in the
spread. If you aren’t charging a fee for
providing a customer with an execution, then by
definition, you are a dealing desk. Period.
Summary
It is important that you carefully look into the
pros and cons of each broker before choosing the
one which best suits your needs. You may also wish
to have several broker accounts to mitigate the
risks, and so that you can compare bid/ask prices
and trade on the broker with the best prices for
the direction you wish to trade.
Because of the unregulated nature of forex, US brokers
are not required to keep your money in an untouchable
account that only you can have access to if they
were to collapse. As customers of Refco (was one
of the world's largest brokers) found out, their
unprotected accounts made them unsecured creditors,
and thus are less likely to get their money back
than those who had given secured loans to Refco.
What this means is that the customers' money was
used to pay other creditors.
The moral of the story is this:
Deposit as little money with your broker as you
need for trading, and withdraw your profits when
they exceed a certain amount. Keep the rest of your
trading capital in your own bank accounts which
are probably
government-insured.
It is HIGHLY recommended that
you investigate brokers and individuals through
the NFA and CFTC websites before you decide to do
business with them.
Here are the links:
To check up on a brokerage or
individual for complaints, infractions, sanctions,
fines and penalties, etc., go to:
http://www.nfa.futures.org/basicnet/
You'll need the brokerage's NFA
resistration #, usually found
on their website. If you can't find a NFA
#, then chances are
good that it isn't registered for some reason (not
U.S.-based
or temporarily or permanently barred from membership
due to
infractions).
Use this link to check up on
the financial health of a brokerage:
http://www.cftc.gov/marketreports/financialdataforfcms/
CLICK HERE
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Differences and Pros and Cons of
ECN's vs Dealing Desk
