2 Questions Your Forex Broker Won't Answer

Most novice forex traders are unaware that a currency pair's price differs from broker to broker. The price, in fact, is set at the broker's discretion. Retail forex is regulated by the Commodity Futures Trading Commission (CFTC) but, unlike stocks, it is still a market without a central exchange. It is controlled by brokers which manipulate the Bid and Ask prices. So the buyer pays the Ask price and the seller pays the Bid price at whatever level the broker determines the Bid and Ask will be. The currency pair's spread is calculated by a formula that averages the Bid and Ask prices of the broker's liquidity providers and the broker adds his profit margin on each trade. So the currency pair price that you see on a trading platform is the price your broker wants you to pay.

Why Do You Care?
Brokers manipulate prices to different degrees and for different reasons. New traders most often seek brokers with the narrowest spreads. But do broker offer smaller spreads for profitability or marketability? It makes sense that a company that processes multiple thousands of trades a day can afford to offer their customers a smaller spread than a company that processes fewer trades per day. So, should a trader always select the broker with the narrowest spreads? This is really only one part of the dynamic that differentiates one broker from another. It is one of the reasons why, when evaluating brokers, a trader must take more than just a cursory look at their website to determine a broker's suitability. What does a green trader, opening their first live account, need to know about a broker? How about their financial stability?

CFTC To The Rescue
The CFTC requires all Futures Commission Merchants (FCM), including forex firms, to report their net capital every month. Any trader can access this public information and analyze the financial stability of a brokerage firm. CFTC's "Financial Data for Futures Commission Merchants" report can be downloaded from CFTC's website monthly in either PDF or Excel format. The report details the actual amount of capital a forex firm has and how much excess capital there is above the CFTC-imposed minimum of $1 million. The FCM report can be used to determine which firms survive on the margins and which firms are relatively stable. Firms having less than $1 million in excess capital should raise a cautionary yellow flag. In today's economic climate, trading with a marginal firm carries too much risk.

What Additional Information Do You Need?
When interviewing a new broker a trader should always ask these two questions:

- "How many retail forex customers do you have?"
- "What is the average size of your retail accounts?"

Most brokers don't want to answer these questions and, in that case, I would pass on them. I would rather place my money with a broker who opts for full disclosure because, armed with the FCM report, number of retail customers, and average account size, I can begin to develop a profile of the type of broker with which I'm dealing. Two brokers with an equal amount of capital but different size accounts can present a very different picture of their financial stability and long-term viability.

By: Tom Herod

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Tom Herod is a full-time forex trader and the Head Turtle at Forexturtle.com. Forexturtle is a free online resource that provides Forex company profiles for Forex traders. Visit www.forexturtle.com