What You Need to Know About
Choosing an Execution Partner

 

You need a “Forex Account” before you can trade currencies.  Where do you set up a Forex account, you ask?
Of course, at a Forex Brokerage.
What is a Forex Broker?
A Forex broker is a company that will allow you to set up an account to buy and sell currencies.  They offer a variety of services such as a trading platform where you can manage your account, place trades, monitor trades, make fund transfer requests, etc.  Essentially, they are the intermediary between you and all of the other traders in the world who want to trade currencies with you.  Quite simply, without a Forex broker, you cannot trade currencies.
In addition to offering trade execution services, most Forex brokers also offer a variety of ancillary services that may be valuable to most traders such as news reporting and charting services.  As well, many offer unique proprietary tools such as pip size calculators, Forex calendars, Forex signals and a host of other tools and resources.  The permutations and combinations that you will see offered by these Forex brokers is endless.
What do Forex Brokers get in return?  The major source of revenue for most Forex brokers is from a form of commission that they generate on each trade you execute.  Most brokers make money by charging a spread between the buy and sell prices for a currency.  Others charge a flat commission on the value of each transaction you engage in.
Types of Forex Brokers
The foreign exchange market is essentially unregulated. There is no central trading exchange nor a global entity that regulates the industry.  What this means as a practical matter is that the prices that are quoted to you from one broker may not be identical to the prices quoted from another.  It is important, therefore, that you understand how a particular broker operates and what the advantages and disadvantages of each are.There are essentially two different types of brokerages – Market Makers and Electronic Communication’s Networks (ECN’s).

Market Makers
Market makers are companies that allow you to set up an account and trade AGAINST THEM.  They usually offer a single bid/ask price spread for each currency pair.  This spread is usually fixed.  The key characteristic of such market makers is that they are on the other side of each trade.  They are literally trading against you.

Advantages of Market Makers

Market makers offer certain advantages:

  • They often provide premium charting functions and news services at no cost.
  • Their pricing features fixed spreads which are certain and predictable.
  • There are many around to choose from.
  • They usually have a pretty intuitive analysis and trading platform.

Disadvantages of Market Makers

There are certain disadvantages to using market makers:

  • Their interests are adverse to yours – They are trading against you.
  • As a result of 1, they may manipulate prices and trigger your stops or limit orders to take you out of positions prematurely.
  • While fixed prices is good for certainty, their pricing spreads are often inferior to ECN’s
  • There may be huge slippage during volatile trading times such as news releases.
  • They often discourage scalping which may be a desirable strategy for some traders.

ECN’s
ECN’s are companies that allow you to create an account with them that lets you trade currencies WITH OTHERS.  Your bid/ask offers are electronically posted and available to other third party traders.  You are NOT taking a position against the ECN itself.  The ECN is simply a facilitator or middleman between you and the party you are trading currencies with.  Therefore, you may see multiple bid/ask prices driven by supply and demand.  Spreads may vary with ECN’s

Advantages of ECN’s:

ECN’s offer certain advantages:

  • ECN’s do not trade against you.  They simply pass your orders on to other customers for execution.  As such, they are not in the least motivated by whether you are successful or not.  Their only interest is in making a commission on your trade.  This will happen whether you are successful or not.  As such, you are not in a battle with your own broker.
  • Bid/Ask spreads are usually superior because of the volume of traders that have access to the system.  In fact, during times of high liquidity, spreads may be very close to zero.
  • You can usually utilize stop-limit orders that ensure there is no slippage.  You can literally set an order that gets filled at the price you want, or not at all.
  • Prices can be much more volatile which can be better for scalpers.

Disadvantages of ECN’s

There are certain disadvantages to using ECN’s:

  • Most do not offer integrated charting services.
  • Most do not offer integrated news services.
  • There are fewer to choose from.
  • Their user interface is not usually as intuitive as those of market makers.

 

 


 


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