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Forex Essentials Course: 21 lessons to get started in Forex

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4. Choosing a Dealer

Thu, Oct 23 2008, 09:57 GMT
by PFX Team

LearningMarkets.com

But there are still significant differences between dealers and you need to understand these in order to pick a preferred dealer. In this section, we will discuss the internal characteristics, as well as well as the external benefits you should look for in choosing a dealer.

Looking under a dealer's hood - Internal Qualities

1. Regulation

The forex market is nearly unregulated, and this means that there are plenty of small “bucket shops” out there soliciting business. Recently, there have been some changes to regulations in the U.S. and Australia that have cleaned up the dealer market somewhat. This is helping good dealers stand out from bad ones.

Dealers usually have to register with some regulatory agency or association. You can find out a lot of information about them—including principles’ names, history, disciplinary problems and complaints by checking out the regulatory agency's website. Below is a list the best places to look for that information. If your dealer does not appear in any system, that is a big red flag. If you don’t know where, or if, a dealer is registered, call them and find out.

U.S.—The NFA’s BASIC system clicking here. This is the most comprehensive resource.

U.K.—The FSA’s website maintains these records here.

Australia—The ASIC has a few records that you can find here.

2. Capitalization

As a registered financial service provider, a dealer is required to maintain a minimum level of capitalization, or money in reserve. This has a direct impact on their ability to remain solvent and is a good indication of the size of the company and its ability to remain in business.

Net capitalization requirements for forex dealers in the U.S. just went up to $5,000,000, which has been a good way to clean out some of the seedier operations. You can find out what your dealer’s capitalization levels are on the CFTC’s website here. If a dealer can’t meet minimum requirements or keeps their capitalization private, you should worry about their ability to remain solvent in adverse market conditions.

3. Service

The most common complaint I get from traders about their dealer’s service is that dealers are abrupt and rude, or that they can’t answer difficult questions. Investigate a dealer’s service and dealing or execution departments. You can do this by doing some research and calling the service department at different times of the day with difficult questions. Make sure that you opt for the dealing desk or execution department a few times to get a feel for how they treat you. You can learn a lot about a dealer by calling them a few times.

Judging a book by its cover - External Qualities

Product line

All dealers are not created equal. Dealer product lines differ in two main areas:

• Pairs Offered: Some dealers offer close to 100 different crosses, which can be great for fundamental or strategy traders.
• Product Offerings: Some dealers offer futures, commodities and options as well as spot forex. We are big advocates of using options in your forex activities so this may be an important factor for you as well.

Spread and roll-over

The spread between bid and ask prices on the majors tends to be relatively uniform across most major dealers. The largest differences exist in the crosses. Be aware that most dealers offer one of the following two spread models:

• Fixed spread: A fixed spread means that you always pay the same spread, regardless of market conditions.

• Variable spread: A variable spread is narrower on average than a fixes spread, often one pip or less on the majors, but can become very wide during periods of market volatility. Very short term traders may lose a trade because the spread widened rather than the market price actually reaching their stop limit. For more fundamental or longer term traders, the spread is less than an issue so competitive spreads are usually sufficient.

• Roll-over: Rollover, interest payments or the “tomorrow-next policy,” are all terms for the interest charge/payment offered by dealers on individual pairs. There is an entire lesson in this course on this subject because it is so important. Call the dealer about its policy and whether higher payment rates and lower charges are available with lower margin levels, higher balances or just upon request.

Charting and execution platform

Dealing platforms fall into two basic categories.

• Execution-based platforms: These platforms are oriented around speed of order entry and execution. You will often see this advertised as “one click trading.” This is great for scalpers and day traders. These kinds of dealers make executing an order very fast and specialize in simple trading interfaces.
• Information-based platforms: These platforms place a much heavier emphasis on charting and research technology. Some of the benefits of the second type of dealer are as follows:

                     - Customizable charting and system development

                     - Display of positions, orders and P/L on the charts

                     - Mechanical system execution

                     - Chart pattern search and identification

                     - Institutional grade news feed and analysis

Making your pick: Tips for choosing a dealer

1. Don’t pick one dealer—pick a few

We think you should avoid constraining yourself to one dealer. This isn’t a marriage so feel free to shop around and trade with dealers that suit each strategy you use in your portfolio. This is also a great way to add some diversification to your trading. While it is rare for a big broker or dealer to go out of business, it has happened. When it does, the results are catastrophic for traders with all their “eggs” in one basket. Many forex traders, interested in options may have to split their account between an options broker and a forex dealer anyway.

2. Prioritize qualities based on what is important to you

You cannot compromise on the internal qualities we listed above, but the external qualities depend on what you want and need as a trader. Long-term traders may value a higher quality news feed and charting research tool than a short-term trader or scalper. Many dealers will say they are a one-size-fits-all solution, but we have not found this to be true.

3. Paper trade

This is not just for new traders. Paper trading a dealer’s application is a critical step before making a decision. Almost all dealers will allow you to set up a paper account to really test the technology and service levels. Spend the time to get to know an application before you make a decision. Too many traders are impressed with surface features in a day or two of paper trading and then make a bad decision.

Forex Essentials Course - 21 lessons:

Published on  Tue, Nov 18 2008, 17:11 GMT