Low Spread Forex Brokers
Choosing a forex broker can be a daunting task. Finding an appropriate business partner that will provide access to the currency trading market at a reasonable cost, will protect your funds at all times through best business practices, and that will respond quickly and effectively when you have a question is not easy, especially when you must deal with someone you may never see “face-to-face” or that resides overseas.
Unfortunately, many traders focus too heavily on cost factors, preferring to go for the broker that advertises “the tightest spreads in the industry” or “near zero spreads on most major pairs”. The facts are that brokers understand their cost structures extremely well or they would never venture into such a business venture. Their objective is to recover their costs in one way or another, the point being that if they subsidize very low spreads, then they plan to make up the difference somewhere else, either in other fees, slippage and poor execution, or low quality customer service and support.
Does the broker type favor low spread offerings?
Forex brokers basically come in two types – ECN brokers or brokers that are market makers. The former passes through your orders directly to its liquidity providers to be executed at their prevailing spreads, which may vary over time depending on supply and demand, but tend to be razor thin. ECN’s may offer a lower spread, but they recover their costs in other ways through commissions or transaction-based pricing. Depending on your trading style and level of activity, an ECN’s pricing structure, when looked at on a total “all-in” basis, may actually be a lower alternative than the typical market maker type of broker.
A market maker, on the other hand, makes his income totally on the “Bid/Ask” spread, which is multiplied if you elect to employ leverage in your trading strategy. This type of broker acts as an intermediary between you, his client, and his bank or broker liquidity providers, choosing rather to “arbitrage” for profit the spread that he offers to you against what he can buy and sell in the market on his own behalf. Each day, the firm maintains an instantaneous accounting of the “overs” and “shorts” for each currency pair. If he is losing at one point, the spread will be slightly increased to make up the difference over time, but the objective is to hit a profit target for each pair at the end of each day.
What to be wary of when choosing a low spread forex broker?
In the business world, all competitors choose to compete either on cost or on quality of service. One cannot be the best at both. In other words, if a forex broker offers “the lowest spreads in the industry”, then it stands to reason that the firm is cutting back on its quality in some other department, will charge other hidden fees that are not immediately apparent, or will resort to bad business practices to disguise its recovery of costs in an unscrupulous manner.
The latter item should be a true concern when low spreads are offered. The first two items will reveal themselves in your due diligence phase of review by comparing the broker’s offerings to the competition and by reviewing customer testimonials or independent reviews of the broker. Bad business practices, however, are more insidious, in that you are at the mercy of your broker. Your only recourse may be to terminate your business arrangement and, hopefully, withdraw your account balance without any delay.
Bad business practices tend to show up in many ways. The first may be in constant re-quoting. You see a quote you like, act upon it with an execution order, but all you get back is a server message with a different quote asking you to try again. The broker chose to block your first request for his own profit reasons, although if you waited beyond an acceptable period of time to act, then the broker may well have been within his rights to re-quote.
Slippage is another practice that can spoil your trading experience and lead to unwanted losses of your precious capital. Slippage results when you send an execution order at a stated price, but it gets executed at another one. The broker will argue that the market is volatile or that you delayed in acting or that a major data release caused the market to abruptly change, but if none of these situations are at hand and slippage occurs frequently, then it is time to question your choice of broker.
Lastly, perhaps the most frustrating bad practice is spread manipulation. Your broker, if he is a market maker, can post whatever quotes are in his best interest at any time. Setting spread quotes is what a market maker is all about, but the unscrupulous ones may suddenly enter quotes that are not necessarily seen anywhere else in the market, i.e., from an independent Reuter’s quote feed or another broker. This manipulation most often occurs when the market is in a tight range. Brokers do not make money under these conditions. When orders start to appear for a big move, the quotes may first go in the opposite direction, roughly 20 to 30 pips, just the right amount to clear out any stop-loss orders and to prevent traders from benefiting from the move. The broker then pockets the profit from those closed client positions in this case.
No one is suggesting that all low spread brokers are bad, just that you should be aware that a low spread broker must make up the difference in some other area. You may not need education materials or customer support. You may want a broker that truly focuses on a low spread and is willing to cut corners in other areas, as long as the firm adheres to best business practices in its execution of your orders.
At the end of the day, spread is important in your broker choice, but you should strive to understand where other hidden costs might be and whether the quality of service might be low, the first complaint that is typically raised in customer testimonials on the Internet. Take your time on the front end to choose your broker wisely.