If you are inexperienced and looking for a new forex broker, you are a bad broker’s favorite mid-day snack. Despite numerous warnings, disclaimers and crucial clauses hidden in tiny print, many people fall prey to bad forex brokers and lose everything. They don’t just walk away without the shiny new Corvette they were dreaming about. They’re left without any money at all.
Market maker forex brokers use many lucrative-sounding words like liquidity, leverage, fixed spreads and margin, which may confuse you. Ultimately, if you do not understand how the foreign exchange market works, you will lose your money – faster than you might imagine.
To help you spot the snakes in the grass, here are five identifying traits of a bad forex broker:
Market Makers – Make Their Own Markets
If you cannot invest at least $10,000 USD into opening a forex account, you likely are going to get a market maker or straight-through processing account. In their disclaimers, you will see that most market maker brokers boldly relate that they will always act in their best interest, regardless of whether it coincides with your best interest. These brokers are called market makers because they make their own markets. In other words, these firms use their assets to manipulate bids, spreads and trades within an intra-company submarket dominated by the firm’s own assets.
If a brokerage tells you that it’s placing your trade order on the open market but your account contract says that the broker makes its money on the bid/sell price, that broker is likely misleading you and is not putting your order on the open market at all. Instead, this type of market maker broker will place your order on an in-house market in which the brokerage can manipulate the bid/sell price to its advantage.
Market making isn’t always a scam. Many reputable firms provide market maker accounts, especially to account holders with low balances. Market making is legal, so make sure that you know what kind of account you are signing up for before you open one.
Commission Free – Is Not Free
Forex brokers that do not charge commissions collect profit from speculating on the bid/sell spread. Ninety-nine percent of the time, commission-free brokers are market maker brokers (see above). No one can stay in business by not charging a commission and losing on the bid/sell price, so in most cases, these firms are market makers so that they can control their profits. Some report that Forex brokers usually only release about 30 percent of their profits to their clients. If you happen to make money on a trade, it is often because the broker’s interest coincided with your bid.
Bucket Shops – A Slam Dunk for Them
No one is going to say, “We run a bucket shop.” Still, many forex brokerages are just that. Bucket shops take your trade order but never actually place it on the open forex market. Instead, they sit on it, or place it in a proverbial bucket, which is where the term comes from. Then, based on the real exchange numbers, and in some cases fabricated numbers, they tell you whether you made or lost money on the trade after the fact, without giving you access to real-time market data. These brokers pay out a little from time to time to appear legitimate, but for the most part, they just keep the profits for themselves.
The term “bucket shop” can also refer to a fraudulent brokerage firm that employs aggressive sales tactics to try to sell the securities it owns and wants to get rid of to ill-informed clients. Before the dawn of the internet and real-time access to market data, these kinds of fraudulent activities were more common. Both of these bucket shop tactics are illegal in the U.S., so if you are suspicious about a broker’s practices, visit a few forums to find out what clients are saying about that broker.
You can see how difficult it could be to prove that a firm is a bucket shop if it is a market maker. However, true market makers have an enormous amount of revenue to maneuver and are audited often, so smaller operations are more likely to be involved in fraudulent trading.
Promises – Pipe Dreams
The forex trading community is full of broken dreams. If you contact a broker and they starting talking about how much money you can make and how fast, hang up the phone and keep looking. A legitimate broker cannot promise you any amount of predictable gains. They might also talk about how cutting edge their trading platform is and so on. Don’t be distracted by a shiny trading interface. Remember, if the broker is a market maker, you are not actually trading on the open market. You do not have total control over the bid/sell spread, and you don’t have all the information you need to make smart investments. All legitimate firms will openly discuss your potential risk.
So, Where is Their Office Anyway?
If you find a forex broker online and cannot pinpoint where their actual office is, beware. There are services out there that can even provide a physical address and what appears to be an actual building to clients. Meanwhile, the real company operates out of the Virgin Islands or someone’s basement in Toledo. It is best to choose a broker with headquarters in your country that you can actually visit. Never send a wire transfer to open an account before you thoroughly investigate the company.
To clarify, there are trustworthy forex brokers. They will frankly discuss the risks with you and execute your orders exactly as you wish. However, keep in mind that, as it is with most services, a larger balance equals better service. If you only have minimal funds to invest, you may want to consider traditional stock trading over forex trading. If you have more than $250,000 to play with and can survive if you lose it, then dive in and have fun speculating on currencies.