Most novice Forex traders are unaware that the price for a currency pair can differ from broker to broker. The price, in fact, is set at the discretion of each individual broker. Although retail forex is regulated by the Commodity Futures Trading Commission (CFTC), it is still a market without a central exchange, controlled by brokers who designate the Bid and Ask price. The buyer pays the Ask price and the seller pays the Bid price and each individual broker determines what the Bid and Ask will be. The currency pair's spread is the result of an algorithm that averages the Bid and Ask prices of different liquidity providers and is then widened by the broker based on how much of the spread he wants to keep. So the price for a currency pair that you see on a trading platform is the price that the broker wants you to see. Careful study of Figure 1 - Broker's Price Feed Window
can illustrate how the broker is able to modify the Bid and Ask prices from the incoming price feeds.
Figure 1 - Broker's Price Feed WindowWhy Do You Care?
Brokers manipulate prices to different degrees and for different reasons. Inexperienced traders generally seek out brokers with the narrowest spreads. But do broker offer smaller spreads for profitability
? 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 you always select the broker with the smaller spreads? This is really only one part of the dynamic that differentiates one broker from another and its a direct reflection of their Level of Maturity
(LOM) as we define it. This is why, when evaluating brokers, a trader must take more than just a cursory look at their website to determine a broker's suitability and LOM. To quote America's own homegrown financial genius Flavor Flav, "Don't believe the hype."
hype, that is...) What does a novice trader, opening their first live account, need to know about a brokers LOM? How about their financial stability?CFTC To The Rescue
The CFTC requires all trading firms, including forex firms, to report their net capital every month. Any trader can access this information and peer into 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. It 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 also be used to determine which firms operate on the margins and which firms are relatively stable. Firms having less than $1 million in excess capital could be on the hairy edge. Would you want to be a customer of a marginal firm if a regulatory issue arose or a CFTC fine was imposed? Brokers which experience regulatory difficulties usually also experience mass client flight, putting them in danger of insolvency.What About The LOM?
To help me get that warm and fuzzy feeling about a firm’s LOM, I always ask my candidate firms:
- - How many retail forex customers do you have?
- - What is the average size of your retail accounts?
Most of them don't want to answer those questions and, in that case, I just move on. I won't place my money with a broker who won't answer those questions because, armed with the FCM report, number of retail customers, and average account size, I can begin to paint a picture of the type of broker with which I'm dealing. Brokers with an equal amount of capital but different size accounts can present a very different picture. Take a look, for example, at Brokers #1 and #4 in the following three graphs.
If you look at the amount of capital each company has on deposit for their customer base, both companies appear to be about the same. But Broker #1 has more than 9,000 customers with an average account size of $2,500 while Broker #4 only has 850 customers with substantially larger individual accounts. Which company fits the profile you're looking for?
When a company boasts, "We are the largest...", what does that really mean? In terms of financial stability and which company you would place your money with, the answer to that question could be crucial.