Choosing a Forex broker

Choosing a forex broker

One sure-fire way to cut through the extensive brokerage choices and options is to undertake the process of elimination.

While in the cereal aisle at the local grocery store, it can be quite daunting to choose the right cereal. However, if you select based on the following three criteria (“Nothing too sugary”, “Nothing that looks like rabbit food” and “Something that has a reasonable amount of fiber”); you realize quickly that you are down to three choices out of a possible fifty. The same is true for brokers. Once you select on the correct criteria, you end up mass-eliminating, knocking out the volume so you can get back to making a more enjoyable choice, the choice between a few.

The criteria for brokers can be put in a few simple questions:

  1. Is the broker’s spread or transaction cost low enough, and can the spread be further reduced by rebates from CashBackForex.com?
  2. What types of execution technologies does it employ (MM, STP, ECN or hybrid)? How honest and reliable are they?
  3. Is the broker registered with a respected authority (UK, EU, US, Japan, Australia or New Zealand)?
  4. What kind of tools does the broker provide?
  5. What kind of leverage and margin policy does it have?
  6. What type of customer support does it provide?
  7. If you do not have sufficient capital, check whether the FX broker offers mini, or better yet micro accounts that require low startup funds? See our article on the benefits of Micro and Nano lot brokers here.

Transaction Cost

The spread cost may seem too small compared to the profits one expects but spreads can add up very quickly. The more trades you conduct, the more the transaction costs mount up, and in the end, the difference in spread between brokers can make or break a system. A scalping system can be particularly sensitive to the spread, being only profitable if the spread is extremely low. Nevertheless, any system can be vulnerable to the spread over time; 200+ trades later in the system’s life, the difference in spread can make the difference between a profitable system and one that struggles for life.

Spread should be a major consideration for every trader because it, and any commissions added to it (as in the case of an ECN broker), represent the transaction cost of making a trade, or the cost of doing business as a trader.

Transaction Cost for Non-ECN Brokers

Transaction Cost = Spread (Bid – Ask)

It is important to note that ECN brokers often offer better spreads than all other broker types, but be careful: they may have lower spreads but at the same time also charge a commission, and this commission cost must be added to the spread to discover the true transaction cost.

Transaction Cost for ECN Brokers

Transaction Cost = Spread + Commission

 

Tip: Transaction Cost for CashbackForex Brokers

If you were to sign up with Introducing Brokers (IBs) who offer a rebate like CashBackForex.com, you would usually earn half of a pip back to your account for every trade, which would considerably lower the spread-transaction cost.

For All brokers listed with CashBackForex:

Transaction Cost = (Spread + Commission) – CashBackForex Rebate

Example of trading EURUSD with FXCM via CashBackForex:
Average Spread on EURUSD (FXCM): 2.7
Cashback Rebate: 0.7 pips
Transaction Cost = 2.7 pip (spread) – 0.7 pips (rebate) = 2.0 pips

How low should we go in this game of reverse spread limbo, lowering the pole (spread) to a maximum height (upper spread threshold) in which we can safely trade without worrying about the spread tripping up our system?
The upper spread threshold will depend on the currency pair, of course, and for your convenience, we have constructed table criteria for competitive spread pricing.

The table lists the currency pair, spread + commission it should NOT be above, and the ideal average range it should be, during decent volume trading hours (3:00 am to 4:00 PM EST):

Currency Pair Average Spread
+ Commission
NOT above
Ideal
Average
Spread +
Commission
EUR/USD 2 Pips 1.5
GBP/USD 3 Pips 2
USD/CHF 3 Pips 2.2
USD/JPY 2 Pips 1.6
USD/CAD 3 Pips 1.8
AUD/USD 3 Pips 1.8
EUR/CHF 3 Pips 2
EUR/GBP 3 Pips 2
EUR/JPY 3 Pips 2
GBP/JPY 3.5 Pips 2.5

The rule of thumb in your process of elimination is that if the broker has average spreads higher than the threshold, avoid it. Keep in mind that these average spreads are what you should expect of a good broker today, given the advanced spread pricing technologies made available. Five years ago the expectation would be 1-2 pips higher for each of the pairs. Any broker who is not currently moving their spreads lower, below the above threshold, is either not taking advantage of the newer technologies and/or remaining greedy. Either way, they are removing themselves from the competition.

Note the mentioned average spread it’s not “as low as” and “typical” spread pricing. What is the difference? The “as low as” spreads advertised on some broker websites are virtually irrelevant and misleading, for you generally can’t even get in or out at these levels. GBP/USD spread may be “as low as” 1 pip, but only for a few seconds per day. Not as misleading, but not quite so accurate either is the publication of “typical spreads”. Different brokers define the “typical spread” differently, and each one should be investigated.

Tools and Websites to Easily View, Track and Compare Spreads

Websites that Track and Compare Broker Spreads

There are also websites that compare different brokers’ spreads, real-time and historical, across a number of currency pairs, such as:

Website Descriptor
Excel Markets > Forex Broker Spreads (this site) Includes relevant, popular brokers.
https://www.myfxbook.com/forex-broker-spreads Includes a large number of brokers.

MT4 Indicators:

There are MT4 indicator tools out there that can be inserted on a currency chart to easily display the real-time and sometimes historical spreads of that chart’s currency pair.

Here are a few that we like:

Indicator Descriptor
StatMonitor_1.1-Phat Displays Spread, Buy/Sell Swap, Volume of chart symbol.
Display Info All Pairs Author: Hanover. Displays valuable information on multiple pairs: Pair Abbreviation [Column1], Bid Price [Column2], Ratio of Day Range to Average Daily Range (also as a %) [Column3-5], Spread ( also as % of ADR) [Column6-7], Pip Value [Column8], Buy Swap Rate[Column9], Sell Swap Rate [Column10].
FXRM Spread History Tracks current spread, max spread and plots spread history.
Multi Pair Spread Monitor Tracks current spreads of multiple pairs.

 

A Secondary Consideration: Look for Brokers Having a Fair and Competitive Overnight Interest Rates (or none at all!)

The broker spread (and/or commission) is the largest part of the transaction cost in forex, and so it trumps most other considerations.

However, there is a secondary transaction cost in forex, and that is overnight interest (also called swap or rollover). See  Overnight Interest (Swap Rate)

Use the first 2 indicators posted in the table above to discover and compare the rates of different brokers to see if they are competitive and fair or check our Forex Broker Swaps Comparison page.

How can you avoid paying swap rates?

There are at least three ways you can avoid paying swap rates. To read more, please check our article Overnight Interest (Swap Rate).

Execution Technologies & Reliability

What makes a reliable broker?

  • Fast execution time in opening and closing trades with minimal slippage.

An unreliable broker will have inexcusable delays in the opening and closing of positions, which often leads to negative slippage. An unreliable broker will also have inexcusable lost connections that prevent trades that should have opened or orphan trades that should have closed.

What makes an honest broker?

  • Low spreads and low commission rate
  • True Swap Rates
  • No re-quotes or very few
  • No slippage when closing trades.
  • Low spread spikes during news events
  • Not running the infamous Virtual Plug-in.

A dishonest broker will fatten the spread and commission beyond tolerable levels, present costly swap rates, and will turn on the infamous virtual dealer plugin in order to create spread spikes, execution delay, requoting and negative slippage on client accounts.  No broker needs to do any of this, for there is plenty of money on the table in a modest spread markup alone, but greed + dishonesty motivates too many brokers to engage in the above cheating tactics.

What makes one broker faster than another?

It is hard to know for sure what goes on behind the scenes, but speculating reasonably broker’s execution speed has to do with four factors:

  1. Supply and Demand Factors
  2. ISP-to-Broker Distance Latency
  3. Execution Technology
  4. Virtual Dealer Plugin Manipulation

1. Supply and demand factors

Newbies mistakenly liken their broker to a supermarket where you pay the price you see rather than a free market where the broker needs to find someone to take your order. Market markers will themselves be the counterparty to your order but STP/ECN brokers will need to find the best available prices from their liquidity partners (or in the case of ECN, the anonymous liquidity pools). Electronic routing technologies have made this price matching process incredibly quick, but it can never be as fast as instant and seamless auto-execution of the prices as seen with a demo. S/D (Supply/Demand) type delays and resulting slippage are most readily seen during high demand periods (such as after a news event when thousands of orders compete at the same time for the same price, causing most trades to enter or exit too late), or during low supply periods (such as the Sydney session when most banks are closed and most traders are not trading, causing your order to wait for a bit as the broker looks for a match). To avoid S/D delays and resulting slippage, try to avoid trading during high or low volume sessions and just after a news release. Note: to add the problem of delay and slippage during news announcement, there is the problem of gaps, and the array of features built inside the virtual dealer plugin that can cancel, disallow, or severely slip pending orders during gaps and news releases.

2. ISP-to-Broker Distance Latency

The distance between your ISP (Internet Service Provider) and broker ISP can create latency in execution. Reason? When you click on a buy order, that packet of data must travel via the internet from your ISP all the way over to your broker’s ISP.  It is measured in milliseconds, or 1/1000th of a second. The closer your respective ISPs, the faster is the delivery of the packets, and the further away, the slower. Latency in online trading can be crucial because data must travel round trip to make a single transaction. A price quote must travel from the broker’s server to the trader’s computer to be processed and then must travel the same distance back to broker’s server to enter, exit or adjust an order. Markets will continue to move while price quotes are in transit, and if market is volatile and latency is high, slippage can occur. When the markets move quickly, delays in milliseconds make the difference between execution at a requested price versus heavy slippage.

The distance delay can be measured in milliseconds by doing a ping test. A step by step test for discovering this type of ping latency can be found in the article “How To Test Your Broker’s Latency“.

Generally, you want your ping test to your broker’s server to be low in milliseconds: 50 or less is ideal and 150 or more can be too much. Bear in mind, if the distance between your broker and your server is 9536 miles (that is the distance between your server in Tokyo and your broker in London), it is not possible for latency to be below 32 milliseconds, as nothing can go faster than the speed of light. Here are two tables that show latency time to popular brokers based on different locations (use for reference only; don’t rush into buying either company’s VPS subscription):

  • Table1 (San Diego, NYC and UK to various brokers)
  • Table2 (US and UK to various brokers)

If you are running a scalping EA and every millisecond delay can be costly, you might want to think about closing the ISP distance gap.

Solution: If you want to reduce the ISP-to-Broker latency as much as possible, you can call your broker and ask if they have a server close to your own ISP, or you can set up a Virtual Private Server (VPS) that is closer to the server of your preferred broker.

3. Broker execution technology

Broker execution technology in retail forex can be broadly divided in two types: the majority market maker brokers (MM-Brokers) who ARE the liquidity providers, and the minority STP/ECN brokers who route your orders to a pool of liquidity providers (banks). We will be discussing each type separately only in respect to execution speed.

MM-Broker and The Possibility of Fastest Execution

Theoretically, the Market Maker Broker (MM-Broker) can be the fastest form of execution, because the broker takes the other side of the trade in-house, instead of routing it out (or streaming prices in) from liquidity providers as would STP/ECN brokers. By definition, a Market Maker is the counterparty to all its client’s positions, and as such he offers a two-sided quote (two rates: BUY and SELL) that mirrors the bank rate.

While the MM-Broker can offset between client’s opposite positions (or hedge via their LP) in the back office, they are usually the first to take the other side of client’s trade (note: this can be very lucrative for them as the odds are that most traders are going to lose 95% of the time). Increasingly MM-brokers (like the MM-banks themselves) have been moving to executable streaming rates instead of request for quote transaction models; this enables clients to click on live rates which are updated in real-time, rather than requesting to deal on a rate which was made “good” for a period of time and may be old. MM-Brokers with executable streaming rates can process trades in milliseconds, if they turned off the delay setting within the virtual dealer plugin. Larger orders greater than 5 standard lots might experience more delay as the MM-broker decides how to offset this greater risk, internally deciding if it can be offset against other client positions, hedged via a partner LP, or hedged against its own capital. Generally, however, most small-time traders trading micro lots might find that they can be filled faster with an honest MM-Broker than with an STP-ECN Broker (though bridge technology out there is quickly closing the gap).

Caveat:
 The MM-Broker can be the fastest form of execution so long as you can find one that is honest.
There is huge temptation out there for MM-Brokers to employ the virtual dealer plugins (discussed below) that create a predetermined execution delay of 1-5 seconds, resulting in slippage in their favor.

STP/ECN Brokers and the greater likelihood of Reliable and Honest Execution

With an STP/ECN broker, they negotiate the best available bid and ask price from the liquidity provider(s), instead of acting as one themselves, and this can be a plus and negative.

On the plus side, there is less likelihood that they will be using the virtual plugin against you, though they still can. Their business model is to act as a mediator to your order, trying to find and deliver the best prices from the pool of liquidity providers, and for this, they charge spread markup and/or commission. As they don’t take the other side of your trade, they are less interested in seeing you lose so they can win.

On the negative side, because the STP/ECN broker is not the direct counterparty to prices they create for you (as with the MM-Broker model), but instead acts as a mediator of prices delivered from the liquidity providers, it can be subject to more real-world delay conditions. At times a market can move very fast, and in these fast times, your market order can suffer from millisecond delays and fractual slippage as it struggles to keep up with the rapidly changing prices streamed in from the liquidity providers. It cannot just fill you at the price you see as with a MM-Broker who makes the artificial market (albeit a market that is mirrored from the bank rates).

Important point:

The quality and speed of execution can vary between STP/ECN brokers depending on two factors: 1) the depth of the liquidity pool; and 2) the sophistication of the bridge technology. The greater the number and diversity of liquidity providers (whether in the form of contracted LPs or anonymous LPs forming an ECN pool) the easier it is for the bridge technology to stream in, at any given moment, the best bid from one provider and the best ask from another. But not all software bridge technologies are created equal. Some are far more sophisticated than others in hunting for (and streaming in) the best bid from one LP and the best ask from another LP. We have been witnesses to software that can so quickly and intelligently differentiate and grab the best bid from one LP and ask from another LP that the resulting spread is frequently negative. Yes, you read that correct, negative! – for instance, the EURUSD bid steams in at 1.26436 and at the same moment the ask steams in lower at 1.26432 (result: -0.4 pip spread), instead of how we see it, as a bid streaming in at 1.26436 and at the same moment a higher ask of 1.26448 (result: 1.2 pip spread).

Working with a near zero raw spreads STP/ECN brokers with deep liquidity pools and sophisticated bridging software can make plenty of money on any spread they choose to deliver to us, and so are more likely to try to lower spreads down to beat their competitors and win more clients, and less likely to employ the virtual dealer plugin grab more money from us.

Those with fewer liquidity partners and less sophisticated bridging software may be more tempted to employ the virtual dealer plugin. Any STP/ECN broker can use, with perhaps a lighter touch than their MM-broker counterparts, the virtual dealer plugin to create a predetermined delay, if even only for a second, causing you to be slipped by 0.2 pips or so, which is additional profit for them (particularly if they take what should be your profitable slippage and only deliver back to you the negative slippage).

Another thought: if the STP/ECN bridging software is rather slow, it works in the broker’s favor and there might be little incentive to make it any quicker : in the interim between when the client executes the market order and when it can be offset by a liquidity provider, prices do change (for better or worse), and if the price moves in the client’s favor (positive slippage), the broker can quote at the client’s tagged price (and pocket the better price), and if the price moves against the client, the broker can quote at the worst price. This is what the NFA discovered about FXCM (see Slippage Cheater #2 ): FXCM stole their client’s positive slippage and they failed to upgrade their electronic software to make it any faster. The greater the software delay, the more potential for slippage, positive and negative, and thus more profit for the broker who wants to steal the positive slippage.

4. Virtual Dealer Plugin

Have you ever felt that your broker is out to get you? Well, you may be right. Do a google search on Virtual Dealer Plugin and MT4 and read up on it. It is pretty scary. See the Virtual Dealer Plugin page for more details.