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Five things to watch out for when choosing a forex broker

This article reveals the top five secret practices that forex brokers engage in. Read through this article and be more careful if you come across any of these practices.

One of the foundations to be a successful forex trader is having the right forex broker on your side.

Not many give this much thought but having the right forex broker can make you or break you as a trader. While a lot is writing about forex trading, analysis, trading strategies and so on, forex brokers also play an important role.

A forex broker, after all, is your window to the world of forex CFD trading

Since you will be trading with your forex broker for a long time, it is important to choose the right forex broker.

But as with anything, there are a few bad apples that spoil the fun for the rest. The world of forex brokers is not an exception either.

There are many recorded cases of how forex brokers duped their clients. It ranges from cases such as preventing a trader from withdrawing money, to manipulating the markets itself.

Amid such practices, traders need to pay attention to the forex broker that they want to trade with.

The forex regulatory landscape is slowly changing. But traders still need to do their homework before choosing to sign up with a forex broker of their choice.

This article reveals the top five secret practices that forex brokers engage in. Read through this article and be more careful if you come across any of these practices.

It is best to avoid a forex broker that engages in one or all of these top five dirty practices they employ in order to make you lose money.

Hopefully, by the end of this article, you are a bit more mature and learn about the traps to avoid when choosing a forex broker.

Before we go into the details of the secret ways a forex broker can make you lose money, we need to talk about forex brokers and the business model.

Types of Forex Brokers

To an untrained eye, all forex brokers may look the same.

However, a forex brokerage can operate its business in different ways. There are two main forex brokerage models.

It goes by different names, but we can classify forex brokers into the following two types:

  • Market makers
  • STP brokers

Market maker forex brokers (dealing desk brokers)

Market maker forex brokers are those who operate an internal dealing desk. With a market maker brokerage model, the forex broker is the market maker. What this means is that the buy and sell orders from traders are executed by the brokerage's in-house dealing desk.

There are obviously advantages and disadvantages of trading with a market maker forex broker.

Many forex traders are wary of trading with a market maker or a dealing desk broker. The reason behind this is the general misconception that the forex broker acts as a counterparty to your trades. This is partly true.

But a market maker does not act as a counterparty to all the trades made with them. In many cases, the market maker forex broker can match one trader's orders with another.

This helps the forex broker to take on undue risk by acting as a counterparty for all the trades placed with them.

To understand this better, let's take an example.

Trader A wants to buy the EURUSD currency pair at 1.1819. The forex broker will look for other traders who are willing to sell at or around this price.

In one scenario, if there is a trader willing to sell at 1.1819, then the orders between Trader A and Trader B are matched. Since the market maker adds a markup on the spread, they make money with this transaction risk-free.

On the other hand, if there are no sellers at 1.1819, the forex broker can step in as the counterparty. In this case, the forex broker now has an open position on their books.

Since this is an open risk, the market maker broker now looks for a buyer to whom they can offload their position (and thus risk) as well.

STP brokers (non-dealing desk brokers)

Another common type of forex brokerage model is the no dealing desk forex broker. This brokerage model goes by different names including ECN/STP broker.

As the description suggests, a non-dealing desk broker does not act as a market maker. In this model, they pass on the orders from their traders to their liquidity pool. For an ECN/STP forex broker to be successful, they need to have a big liquidity pool (or it would be impossible for them to execute the orders.

No dealing desk forex brokers usually connect into a wider liquidity pool. These liquidity pools are usually networks comprising of other forex brokerages.

For providing this service, the no dealing desk forex broker makes money by charging a commission on the trades.

These commissions are known as round-trip commissions. You pay a small fee when you open a trade, and you also pay a fee when the trade is closed.

On top of the commission, no dealing desk forex brokers also apply a mark-up on the spread. This allows them to run a successful no-dealing desk forex brokerage.

Many forex traders believe that a no-dealing desk forex broker is more ethical than a market maker. But this is not true!

The main difference with a no dealing desk or an STP forex broker is that the spreads can vary. Hence, they often advertise themselves as offering variable spreads.

What is a variable spread?

A variable spread means that the spread (the difference between the bid and ask price) can change continuously.

The spreads get tighter when there is high liquidity in the markets. This is usually during an active trading session.

On the other hand, during off-market hours, the spreads can widen or increase. This happens because liquidity drops off. Hence, the difference between bid and ask can vary quite a lot.

The change in the spreads, when using a variable spread broker can be observed especially for exotic currency pairs.

Five practices forex brokers use to make you lose money

Now that we understand how a forex brokerage model works, let’s dive into the main part.

Watch out for the below points!

If you find a potential forex broker engaging any of these methods, be extra careful!

1. Enticing traders to deposit more by offering bonuses

Just under half a decade ago, forex bonuses were common. A forex bonus is where the forex broker offers you free money on top of the deposit you make.

A forex broker could advertise such an offer by claiming to give you 50% of your deposit amount as a bonus.

But the extra money you get in the forex bonus has strings attached. In order to withdraw any profits or even your remaining capital, you need to meet some conditions.

In most cases, these conditions could be a requirement to trade x number of lots. The number of lots required to trade is typically high.

A trader may end up overtrading on their account solely to meet the condition so they can withdraw their capital.

Forex regulatory authorities have been clamping down on forex brokers offering such bonuses. A more recent case is the example of a forex broker that was shut down by ASIC (Australia Securities Investment Commission).

As a forex trader who is on the lookout for a forex broker, you should be wary of brokers that entice you with these bonuses. Although the idea of extra money for your trading capital sounds good, it is a bad idea.

Traders will not be able to meet the trading requirements and will end up losing their entire capital.

Depending on the terms, you may find that the trading lot requirements are applicable to only a few currency pair CFDs.

This can further delay how soon you can meet the trading conditions.

In short, if you see a forex broker offering bonuses, deny the bonus right away. Or, if you have a chance, avoid using such forex brokers entirely.

2. Forex brokers who are registered offshore

More and more forex regulators are tightening restrictions on forex brokerages. This includes aspects ranging from forex bonuses that we just covered. It also spans other areas such as audits and leverage restrictions.

In the U.S. forex example, the Commodity Futures Trading Commission (CFTC) restricts forex leverage is to 1:50 since 2010.

Almost a decade later, (ESMA) European Securities and Markets Authority introduced forex leverage restrictions as well. Similar moves followed by other regulatory authorities such as the UK’s FCA and Australia’s ASIC.

What this meant is that forex brokers operating with a trading license could not allow traders to use higher leverage.

Since forex CFD trading is risky and given the fact that many forex traders are not investment professionals, there was a high chance to lose money. In order to protect the consumers, the forex leverage restrictions came into force.

But despite these measures to safeguard traders, some forex brokers turned to offshore jurisdictions. These offshore jurisdictions include forex brokers registered in places like Cayman Island, Bahamas, Seychelles, Mauritius and so on.

Can you trust offshore forex brokers?

One of the main reasons a forex broker operates offshore is to circumvent the restrictions. However, this can be disastrous if you are a new trader.

The offshore forex jurisdiction does not give enough protection to the trader.

This means that if things go wrong, there is nowhere a forex trader can turn to.

An undercover report from the BBC in June 2021 revealed how an offshore broker duped their clients.

There are many instances such as these. At the end of the day, sadly, greed overtakes logic when it comes to choosing a regulated forex broker.

3. Forex analysis with a focus on hype

You do not have to look around much to discover forex analysis and articles that build up hype. Typically, forex brokers tend to publish ‘expert analysis’ around major news events.

Traders are curious to know how a currency pair will perform in the run-up to a news event such as an interest rate decision or the US nonfarm payrolls (NFP). These events can move the markets wildly.

Forex brokers capitalize on this hype by publishing analyses on how best to trade such events.

Since these are highly volatile events impacting the forex markets, a new trader can easily lose money. Even worse, if the so called ‘expert analysis’ is wrong, the trader who bets too much can lose all their capital.

In the heat of the moment, a forex trader can easily fall trap to such subtle marketing messages. These analysis pieces are made for a reason.

Forex brokers often capitalize on the ‘scarcity’ of such opportunities. This in turn makes the trader into feeling left out. Hence, the trader ends up taking on a trade. The question as to whether the trader makes money or not on that trade is open, of course.

In trading jargon, it is referred to as FOMO or the Fear of missing out!

The truth is that news events like payrolls, interest rate hikes happen throughout the year. And just because you sit one out doesn’t mean that you lost out on a once-in-a-lifetime trading opportunity.

4. Hidden fees on your forex trading account

The devil is in the details! And this could not be further from the truth when it comes to forex brokers.

One of the most important things to bear in mind is to read through the broker’s terms and conditions. Although a forex broker primarily focuses on spreads and leverage, there may be other hidden costs.

For example, a forex broker may charge you extra money if your account is inactive for a certain period.

If you are a part-time trader, then these fees can quickly eat up into your remaining trading capital. Besides the inactive account fees, forex brokers may also charge additional fees such as high commissions when you withdraw money from your trading account.

The best way to avoid such nasty surprises is to read through the forex broker’s terms and conditions.

In many cases, the forex broker clearly outlines their terms, including any additional costs for trading. Sadly, however, traders do not read these documents and when they are hit by additional fees, they end up blaming the forex broker.

However, an ethical forex broker will ensure that such information is easily available for traders and not buried in pages of fine print with legal jargon.

5. Aggressive marketing practices from the time you open a demo trading account

Forex brokers offer a demo trading account. The reason behind this is to allow potential customers to test out the broker’s trading conditions.

Sometimes, traders sign up with a forex broker simply to access their demo trading account.

You are often required to give your email address and phone number when signing up for a demo account.

There are some forex brokers who are aggressive when it comes to their market strategies.

From the time you sign up, you are inundated with phone calls and emails asking whether you want to sign up with a real trading account.

Forex brokers employ such under-the-belt practices that often go unnoticed. Therefore, if you come across forex brokers using such methods, it is best to stay away.

In some cases, the forex brokers can also employ pressure tactics to entice you to fund your trading account. Simply walk away when you come across such marketing practices.

Busting some popular myths about forex broker practices

Having outlined some of the ways forex brokers use tricks to trap you into depositing more money, there are some myths floating around as well.

Let’s take a look at a few of these.

Myth #1: Market makers are bad. Period!

Many forex traders have an illusion that market-maker forex brokers are bad. But that is not the case all the time.

A market maker is one who makes the market when there is none. In the forex context, a market maker is a dealer that gives you the bid and asks.

A business cannot survive without making a profit and this is true with a forex broker as well.

Traders think that a market maker is out there to get their money. But this is not the case all the time. A market maker is ideal especially if you prefer the convenience of a fixed spread. Moreover, a market maker does not charge additional fees such as commissions.

With a non-dealing desk forex broker, you end up paying a commission and a mark-up on the spread which only raises the costs for you.

A very good example can be seen during 2015 when the Swiss national bank shocked the world by removing the CHF peg to the Euro. When this happened, traders using a non-dealing desk broker suffered huge losses.

This was despite using stop losses. Since there were no orders below the peg, traders ended up owing money to their brokers. A few non-dealing desk brokers also lost their business overnight.

Myth #2: A Book and B Book – You will never know

Another popular myth among traders is rumors about a broker using an A-book or a B-Book.

An A-book is a trading book where the traders are executed in-house. On the other hand, a B-Book is trades passed on to the liquidity providers.

Traders falsely accuse forex brokers of using A-book based on a hunch rather than backed up by facts.

The truth is that unless the forex broker specifically mentions this, there is no way of telling. You simply would not know whether your trades are executed in-house or passed through.

Myth #3: Stop hunting by forex brokers

Traders blame their forex brokers of stop hunting, but this is laughable.

Stop hunting is a term that refers to prices moving toward your stop loss and triggering it, before reversing direction. With stop hunting, you lose money before the market proves you right.

Unless the forex broker has the entire market for themselves, this is not possible.

Stop hunting is mostly because of traders using a very tight stop loss and inadequate trading strategies. In such cases, it is easy to blame it on their forex broker.

How to avoid getting scammed by a forex broker?

We have covered quite a bit of ground on the secret practices forex brokers use. Here is a quick summary of how to avoid getting scammed by a forex broker.

Due your due diligence when choosing a forex broker

Better be safe than sorry is the philosophy to stick to! Forex traders should spend enough time learning about the potential forex broker before committing.

This means, doing background research on the business itself. You can also look to the competent authority and search on their website if the broker is really licensed or not.

Take online forex reviews with a pinch of salt

You may come across reviews of forex brokers. There are many websites that do it. These forex review websites are compensated every time a potential trader signs up from their link.

Hence, it is in the best interest of these websites to provide a ‘good review’ of the forex broker. Therefore, do not blindly trust the online forex reviews, especially from websites that are in the sole business of promoting various forex brokers.

Read the terms & conditions from the forex broker’s website

Yes, a forex broker’s terms and conditions may be boring and complicated. But spending time reading through the terms can go a long way.

It will help you avoid any nasty surprises in the future. In many cases, forex brokers put up their terms upfront. It is only in the best interest of the forex trader to ensure they have read the terms before signing up.

Start with a small deposit first

Never go big on the first deposit. Start with a small deposit that won’t hurt your pocket. Test out the trading conditions from the forex broker and get a feel of things.

You should even try withdrawing your money to see if you face any resistance. This will help you to slowly build trust with your forex broker.

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Disclaimer

The information provided is of a general nature and is not intended to be personalised financial advice. The information provided is not intended to be a substitute for professional advice. You may seek appropriate personalised financial advice from a qualified professional to suit your individual circumstances.

Trading in Rockfort Markets derivative products may not be suitable for everyone as derivative products may be considered as high risk. Please ensure that you understand the risks involved. A Product Disclosure Statement can be obtained here and should be considered before trading with us.

William B

July 13, 2021

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