Selecting a Forex broker is a complex process, and it is important enough that it can either make or break your chances for a successful Forex experience. Our goal is to highlight what makes this decision important and offer some key tips to making a good selection.

Forex Datasource estimates that there are approximately 100 medium or large Forex brokers in the world today, each of them with unique features. The rate of new brokers has decreased considerably, though. The retail Forex market is maturing a bit. New regulation and tough broker competition force new brokers to come up with a lot of capital upfront to have a chance at surviving the first year of business.

Based on our experience, there are four attributes that a reputable Forex broker should possess:

>  Trading technology that is attractive and stable
>  More capital than the minimum required
>  Qualified personnel
>  Responsive management

Furthermore, there are three goals that should guide your selection:

1.  Identify your Forex account priorities
2.  Conduct a thorough research of brokers (the most tedious part)
3.  Select a broker that is strong in the areas that appealed the most to you in step 1

The common pitfalls of Forex traders

Before we jump into the desirable qualities of brokers or the right way of selecting a broker, I would like to spend a moment and illustrate why you should care about this subject. We can all learn from the mistakes of others.

Mistake 1. Select a broker too quickly. We typically hear someone brag about a fantastic return they made trading currencies. That urge to do the same makes it so tempting to skip the broker selection stage, to get on with real trading. Without knowing anything about your skill or IQ, we can almost guarantee that if you skip the broker selection process your initial deposit - whether it was $50 or $50,000 - it will be lost in 45 days. The new trader is probably not ready for trading, has little risk management training, and worst of all, does not understand how Forex brokers make money. Do yourself a favor: take it easy and be methodical to do things correctly. The Forex market is not going away tomorrow.

Mistake 2. Assume too much, ask too little. The average trader who opens a live account will not take the time to ask the broker things like: do you have a dealing desk?, how many banks give you Forex prices?, what is your policy for scalping?, etc. So, let's say that you heard that trading the news can make you a lot of money. You think you are clever because you select a broker that has fixed spreads, so when the news announcement comes the spreads will not change. The problem you did not contemplate, however, is that your chosen broker may not allow you to trade during news announcements. Do yourself a favor: Don't assume, ask all the questions that are important to you upfront before you fund the account.

Mistake 3. Over-react when a trading problem happens. Trading problems or surprises are part of a normal experience trading Forex. The problem may be how a stop loss was executed, or how long it takes to open/close orders, or the charts freezing at the wrong moment, etc. Being hit by a surprise like that can be costly and will typically cause a shock to the new trader. This shock along with a lack of knowledge of how things work will almost always lead the new trader to say that he has been scammed. He will immediately seek out a forum or website where to vent his frustration and will start his search for a new broker. Do yourself another favor: Educate yourself about the things that can and do go wrong. Very often, you can control and prevent these types of problems by careful broker selection and by the type of trading you engage in.

Mistake 4. Deposit money where you shouldn't. We live in uncertain times when the largest of banks have suffered a crisis of confidence. Brokers are like mini-banks. If enough traders try to pull their money from a broker at the same time, the broker will be forced to freeze client funds. That happened in 2005 with Refco, the largest Forex broker at the time. In hindsight, there were some lessons to help us today. Refco's FX division was regulated off-shore. The regulation of brokers in the US and UK is very strict and it would be extremely hard for a US regulated broker to pull a scam like Refco. Be smart: Try to do business with US/UK regulated brokers unless you have good reasons to keep your funds in other jurisdictions.

Mistake 5. Repeat the same mistakes over and over. You would be surprise how many traders never really learn the right lessons from problems that happen. Too often the solution for a trading problem is to get a new broker. But changing a broker will not necessarily cause you understand what went wrong and how it can be avoided. Not all brokers are crooks, just like not all traders are losers. Our recommendation: Read the Forex Datasource report Essential things to know about broker operations, this reading will add more clarity about the complexities of order execution once you put on a trade request.

The attributes that any Forex Broker should possess

>  Trading technology that is attractive and stable
>  More capital than the minimum required
>  Qualified personnel
>  Responsive management

A professional Forex broker takes seriously its role as a sophisticated provider of trading services. Sadly, there are plenty of Forex brokers with $500,000 in initial capital that think that with a nice website, a leased backoffice software and five employees, they have all that is necessary to start receiving money from Forex traders. The basic architecture of a Forex broker - see graph below - is something that is complex and typically costs millions of US dollars. It is comprised of hardware, software, support personnel and experienced managers.

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For a detailed explanation of this graph, read our article: Essential things to know about broker operations

I.   TRADING TECHNOLOGY

Trading technology refers to having, first of all, a trading platform that is stable and appeals to traders. There are many examples of trading platforms that have been developed internally by Forex brokers and that fail to meet the standard in the industry. These platforms may lack integrated graphic components, or the ability to customize the different parts, or technical indicators or the ability to accept automated orders. One of the most complete and most popular trading platform today is MetaTrader 4 (MT4), developed by a Russian software company called MetaQuotes and inspired by a Reuters-owned US company called MetaStock. Recognizing the demand for MT4, several major brokers added MT4 to their product lineup in 2008.

But whether MT4 is right for you or not, it is important to understand that a trading platform and its supporting backoffice software may not always dependable. For a 2-year period (2005-2007), MT4 frustrated many traders because it was not stable. Almost daily updates from MetaQuotes to fix problems demonstrated that the product had been launched prematurely. Traders could not assume that the software would work as intended. Many traders suffered losses due to these glitches and brokers using the software were very frustrated.

I've also experienced firsthand the long, expensive and difficult path of developing internally a powerful and stable trading platform. If I hear a broker firm state that they have developed a software internally and that the development team has less than 40 employees or that it was developed in less than 3 years, I would be very cautious before trading live in it.

II.   MORE CAPITAL THAN THE MINIMUM REQUIRED

As we have stated previously, having the right technology and personnel requires a multi-million dollar investment. On top of that, the firm has to keep the minimum amount of capital required by reputable government regulators, such as the U.S. National Futures Association (NFA), or the U.K. Financial Services Authority (FSA). But if brokers want to inspire more confidence, many of the major Forex brokers have come to realize that they need to put more capital in the balance sheet than what they have to by law.

Conversely, there are many brokers, perhaps more short on capital, that only keep the minimum required by regulators. Yet other firms, are not regulated by a reputable regulator and do not reveal how much capital they have or who are the capital sponsors of the firm. An unregulated firm lacks transparency and implicitly expects its clients to trust that it has sufficient capital to operate properly.

III.   QUALIFIED PERSONNEL

I recall one situation when I talked to the CEO of a small brokerage firm in 2006. This CEO shared with me how his office had just participated in an all-day charity event. He told me they had 14 employees. I knew from other sources that they were successfully competing with 2 bigger brokers for one trading group of about 4000 traders. I remember thinking, how is it that this small firm can provide adequate service to more than 1000 clients and how is it that they could afford to take a workday off when the demand of being a broker are so rigorous, specially for a small firm? It was not a major surprise when the NFA shut down this company a year later for poor internal procedures and inadequate capitalization.

The qualifications for a broker personnel are straightforward:


>Have sufficient employees to service clients. Forex traders need to call and ask questions, they need a speedy account opening process and withdrawal request. They also need quick answers when there are problems. There are still brokers that require paper new account forms. Conversely, there are many brokers that offer the convenience of secure web access to take care of many account maintenance issues. In the account setup process and interaction with client service personnel, a Forex trader will quickly realize if the broker has an adequate number of personnel providing support.

>Have sufficient employees to service the backoffice. Forex traders need personnel that makes sure that can help insure a quick execution and a high uptime for the system. The absence of technical problems is a sign that the firm is probably devoting the necessary resources to its backoffice operations. Conversely, frequent downtime, trade problems, and poor execution may be signs that the firm lacks the resources or sophistication to address technical problems.

IV.   RESPONSIVE MANAGEMENT

I have come to expect a Forex broker to disclose the names and relevant experience of the department heads in key areas, such as IT, trading, compliance, and marketing. When I read that a firm was started by a group of traders with experience in currency markets, red flags go up in my head. The proper management of a firm calls for the vision of a CEO who has vast experience in retail Forex, but the specific skills of managers who have established reputations in their respective field of work. Again, the less reputable firms will not likely disclose this type of information, but the serious ones will do so.

One can measure the effectiveness of a Forex broker on this regard in two ways: 1) disclosure of relevant personnel data, and 2) the overall direction of the firm. This second point requires time to be able to gage if a firm is going in the right direction or not. All broker firms will experience an occasional system downtime, or regulatory reprimand, or poor client service. But firms that persist in these type of problems or repeat the same mistakes gives proof that the leadership of the firm lacks either competence or will to serve a demanding trader client base.

KEY STEPS IN THE BROKER SELECTION PROCESS

1.  Identify your Forex account priorities
2.  Conduct a thorough research of brokers (the most tedious part)
3.  Select a broker that is strong in the areas that appealed the most to you in step 1

1.   IDENTIFY YOUR FOREX ACCOUNT PRIORITIES

It is appropriate to use an analogy to describe why there is not a single broker that is ideal for everybody. If 100 people are given $500 each to buy groceries in a supermarket, is there a grocery list that will work for all of them? No, because some are allergic to some foods, and each person will have different meal preferences.

Selecting a Forex broker should be a reflection of what your account priorities are. Too many people don't take the time to analyze what is important to them. They make the mistake of assuming that one broker will give them everything they want.

Therefore, the first task is to take inventory of what are your Forex account priorities. The list of priorities can be large and diverse. For some people, it is important to do business with a broker that offers low spreads and no commissions, others want fixed spreads, other want Islamic accounts, while others value brokers that authorize scalping and trading the news. There are those who value a broker office located in the same country where they reside, others that value an off-shore broker, and others that require a broker regulated by the NFA or FSA.

Once you identify the two-three things that are really important to you in a Forex trading account, then you are prepared to start the search for a broker. It is helpful to know that in its Trader Concierge Program (TCP), Forex Datasource offers a comprehensive list of factors that help traders to identify what is most important to them. Participation in the TCP can be free, for more information contact info@forexdatasource.com

2.   CONDUCT A THOROUGH BROKER RESEARCH

Armed with an understanding of what is important to you in a Forex account, you are ready to start the search process. The ForexDatasource.com database for the top 50 broker dealers is a good starting point. You will want to understand what is known about those firms, what financial data (if any) is reported to regulators, what current and past clients say about them, and compare several firms using objective industry benchmarks.

A second step would be to visit the websites of the few firms you are considering as the best candidates. Navigate through the pages and see if you can easily find the information that is useful to you.

A third step is to prepare a list of questions to ask from each of the brokers you are considering. We would recommend doing your interview by phone or by chat. You will want to tell the broker that you are conducting due-diligence on a few brokers before opening an account and that you would like to ask them a few questions.

A good question to ask brokers is: what are the two-three things that you feel your firm can deliver to traders on a consistent basis or that it is known for? They should answer things like: we offer fixed spreads, a stable trading environment, no dealing desk, etc. Hopefully, part of their answer to that question will be one or two of the few things that are most important to you in a Forex brokerage account. If you hear a broker describe as one of its strengths something that you are looking for, then maybe you have found a match. Congratulations!

3. SELECT A BROKER RIGHT FOR YOU

Once you have found two or three firms that sound good, then it is appropriate to give one of them a try. Again, do not assume that there is only one broker or that you have found the best one. What you have done is to systematically narrow down your options from 100 medium to large brokers to one or two. There is no good reason why you should think that you owe loyalty to a broker. A Forex brokerage account should always be a calculated business decision. It is the responsibility of the Forex broker you select is to continue to earn your business day after day. If they do not do so, you should not hesitate to explore other options.

There are two more important facts that you should keep in mind. Traders preferences evolve with time and broker offerings in the market evolve as well.

Maybe you started your Forex experience thinking that you wanted to trade the news or that you wanted to do carry trades. After some time, maybe you have found that those interests do not work so well for you and you decide to try swing trading. As your preferences evolve, be aware that your initial broker choice may no longer be the most suitable.

It is also true that the broker landscape changes quite a bit. Let's say that you are looking for a well- capitalized broker offering MT4 trading platform - that is what is important to you. You really like the capitalization of a large broker, but decide to choose a medium-sized broker that offers MT4 because the large broker does not offer that platform. If you keep up with broker news, you might learn that the large broker announces that it now offers MT4. Of course, this news release might signal a potential re-evaluation of whether to continue to use the same broker you originally selected.

A key point that we would like to make is that even though you may have selected the broker that should give you the most satisfaction, trade-related problems will arise. If an incident happens and upsets you, it will be relatively easy to leave that broker and shop for another. That is certainly one option, but it should never be the first option.

The first option should be to try to understand the superficial and the underlying cause for a problem.

This means that if a stop loss was not honored at the desired price to try to understand why. Maybe your initial impression is that the broker is trying to take advantage of you. Upon closer inspection, you may realize that an unexpected incident happened in the market that caused a 1% move in currency prices. You may further learn that during this announcement your stop loss was triggered but the price you had requested did not trade during the post announcement price spike. The price you wanted was skipped, something that is quite possible and happens regularly in currency markets. So the superficial cause of the problem may have been caused by the news announcement. The underlying cause of your frustration could have been that you were not aware that your stop loss would be filled at the first available price. If you had known this, maybe you would have closed the trade sooner. The lesson we wish to impress is not that the broker is probably right and you are wrong, but rather that it cost you a lot of time and effort to find a suitable broker, do not be hasty to end that relationship.

Finally, we would like you to know that sometimes it is hard to know when a broker is telling the truth and if their explanation of a situation is plausible. For example, you have an account that has open trades, showing a considerable floating loss. Your broker tells you that they need to move your account to a new trading server very soon and the only way of doing that is to close all open trades. Doing what the broker tells you would obviously cause your account to realize a real loss.

It is in these times that you need to have an independent third party, with expert understanding of broker operations whisper in your ear your options.

We trust that this document has illustrated ways around the complexity of selecting a Forex broker. We also hope that you are now better prepared to start the selection process. If you have any questions on the materials covered, please do not hesitate to contact Forex Datasource.