Usually most traders focus most of their efforts on the search for a good system or EA to get optimal returns on their investment.
What most traders don’t realize however, is that a good broker can have a large impact on those expected returns. And as you’ll find out in this article, spending time on selecting a good broker can certainly pay off. Big time.
Since 2007 there has been an explosion in the number of forex brokers available to the retail trader. While there were only a few to choose from four or five years ago now the number would be in the hundreds, if not higher. While we are spoiled for choice, choosing the right broker can still be daunting task.
When comparing brokers, traders tend to base their primary ranking on the following criteria:
No surprise: the spread tops the list, as it’s a quick and easy way to compare brokers. However, before diving into the nitty gritty of how spread and pricefeed can influence your trading results, let’s start with dividing brokers into two buckets first: Dealing Desk/Market Maker brokers and the Non-Dealing Desk brokers. Because that’s where a lot of trouble starts.
This type of brokerage is probably the first to come to market. These brokerage houses trade on their own equity (they have little or no access to liquidity providers) and “make the market”. This usually means they take the opposite of your trade on their own account.
For example: the “Dealer” receives an order from you to go long, and if he accepts your order he might take the short position or match that with another order from another client who wants to go short at that time (so their order book is ‘balanced’ and their own exposure is now reduced).
One of the main tasks of the Dealer is to ensure the broker maximizes profits and reduces its own exposure to a minimum. To maximize profits and reduce his exposure, the Dealer has access to numerous tools to manage his business and balance his orderbook.
In the screenshot above, you’ll see just one example of how the Dealer can actually ‘manipulate’ your order. The Dealer can choose to delay your order, reject it, or issue a requote and offer you a different price. Note how they can increase price and spread at free will.
The business model of these types of brokers is simple: maximize returns on spread, delaying orders, filling orders at different price requests (requotes) to ensure the odds are even more against you. Moreover, when the balance in the orderbook allows, they can initiate stophunts by moving price up or down in quick spikes to trigger your stops.
Below you’ll find screenshots from the Metatrader4 Market Maker Handbook, showing the Quote tool.
As you can see, the broker (Dealer) can adjust the spreads on a global level for each pair and add the spread to the quotation flow in the pricefeed. This is called “mark-up on the bid”, and will alter the actual pricefeed and thus impact your EA results.
Unfortunately, yes. For example, have a look at another tool brokers have at their disposal, the Virtual Dealer Plugin, developed by Metaquotes, the same developers that gave you Metatrader4.
With this tool, forex brokers can stack the odds even more against you. They can manually or automatically delay execution, slip your trades, trigger stops and stopouts, and even –silentlly and temporarily (!) - adjust your leverage to enforce a margin call.
But don’t take our word for it, have a look at the screenshots below:
If you’re interested in reading more about this, the complete PDF can be downloaded here.
Well, there is hope. Have a look at this video:
The guys from 4xTrader.net seem to have developed a great tool called 4xSentinel to detect suspicious broker activity. We’re testing it at the moment on our live accounts. If you want to know more about this tool, have a look at their website: 4xtrader.net
These brokers play a different role. They basically ‘pass on orders’ to their liquidity providers. Non-Dealing Desk (NDD) brokers are often also called Straight-through Processing (STP) or Electronic Communication Network (ECN) brokers. More info on what the differences are and how they operate can be found here:
http://en.wikipedia.org/wiki/Foreign_exchange_market (also shows major liquidity providers)
The business model of these brokers is relatively simple: they receive commission on every order placed from the trader and might receive commission from their liquidity providers as well, based on volume. Alternatively, they can ‘pad the spread’ to make money.
The liquidity providers these brokers rely on are usually large banks, and most of the NDD brokers are connected to the interbank feed via a bridge, allowing them to put every order straight through to the interbank network.
Since they don’t manage their own orderbook, these brokers tend to be more honest for the trader, as they don’t have to manipulate orders and/or take the opposite side of our trade to make money. However, they can still ‘influence’ the trade by marking up the spread and delaying orders. Also, if they don’t have access to good liquidity, your orders might be filled at a worse price (slippage).
Please do realize that NDD brokers who advertise “no commission charges” are the ones you want to avoid, as they get income from padding the spread using the tools described above, and thus influence the pricefeed. Now, some of them might claim they get their revenues from their liquidity providers based on transaction volume, so check with them first.
We feel the true ECN broker charging a commission is the one type of broker that has the least incentive to ‘mess with your trading’.
Comparing spreads on the currencies you most often trade is a good first way to draw up a short list of brokers.
Some sites with quite good comparative spread tables are:
For the two pairs the KangarooEA trades you should only accept a broker if it offers spreads that are less than 2.0 pips for the EURUSD and 3.0 for the AUDUSD on average.
Not only are you doing yourself a disservice by paying more, but at higher spreads, something else comes into play: a change in the pricefeed. And while paying a bit more spread may seem acceptable, the alteration of pricefeed may actually negatively impact your trading results a lot more than you think. For example, EAs might be coded to trigger a signal at the Ask price or to close a long trade at Ask. Now, the larger your spread, the more risk you run of missing the entry signal or fail to close this trade successfully.
Probably the most undervalued feature when comparing brokers is the pricefeed. We’ve all heard about it and mentioned it int his article already a few times. But what is it and how does it influence the results?
Well, as we’ve seen above, some brokers have their ‘own’ pricefeeds (Dealers with own orderbook) while others rely on pricefeeds from their liquidity providers.
The concept behind the pricefeed is actually very simple: It describes when and how the bars are formed on your chart. For every tick that comes in, a new price is established and a new part of the bar is drawn. Since every tick represents a trade that took place, the more ticks you receive from your broker, the more realistic the pricefeed. This means your broker has access to lots of liquidity and prices probably reflect the current market situation accurately.
To illustrate this, take a quick glance at the two screenshots below. Don’t read the comments yet. And decide which broker you like best. Click the images to enlarge them.
Now, how can differences in pricefeed impact our trading?
Have a look at the screenshot below.
Note: On both brokers, TP was hit and all positions were closed in a nice total net profit. However, the first broker (left) took just longer to reach TP.
This is just one example of how pricefeeds that may appear totally similar to the eye, can impact results rather drastically when trading.
Once you’ve selected a good broker and you’re ready to test your EAs in forward testing, you might be in for another surprise. As just about everyone tells you in this business, you should test your EAs on a demo account first. We agree with that to a certain point.
Have you ever noticed that your EA makes tons of money on demo, you get all excited, start dreaming about that new Porsche or sailing yacht, rush to open a live account only to discover your actual live results are completely different from what you first expected?
I think we can all relate to this situation from experience.
Here’s what happens.
First of all, demo accounts do not suffer from lack of liquidity. So you always get filled on the price you requested. No slippage. This is especially true for the so-called Asian scalpers. They trade during low liquidity times after NY close and before Asian open. On demo, all looks fantastic, but on a live account, you will get slipped and this can results in less profits or even losses.
Second, most brokers don’t offer the same pricefeed for demo and live accounts. There might be a difference in spread, or a slight delay of the demo feed, impacting the way the EA trades.
So next time you put an EA on demo, make sure the pricefeed is the same as the live account. Check with your broker, and ask them about this.
And please do realize demo results will seldomly reflect your results on a live account due to slippage.
Once you have gotten your head around all the technicalities of a broker and understand how the odds might even be more stacked against you than you initially thought, the next series of questions that should come to mind: Will my money be safe with this broker? Where does the broker operate? Is the broker regulated by an authority which has a reputation for being prudent and studious in its monitoring of brokers? That is – is the broker regulated in the US? Britain? Australia? Or are they regulated in Central America? Indonesia?
As a general rule, the European Union, the USA and Australia offer the most rigorous regulation. Russia, Central America are known to offer less strict regulations. So stick to those regulated in well-regarded countries and who display their license number on their websites. When considering a broker, ask them for their license number and verify it. A Google search can verify their claims easily.
Finally, when something does go a bit wrong, you want good customer service. So test them out. Give them a call, have a live chat and have a general conversation. Ask them about regulation, any EA or trading restrictions, slippage, spreads during rollover time, cost of carry (swaps) and deposit and withdrawal methods and times. They should be happy to answer all those questions in full.
A good point of reference before making the decision to jump into bed with a broker is to check out the Forex Peace Army broker review pages(http://www.forexpeacearmy.com/public/forex_broker_reviews) – with public comments from traders just like you and me.
Another nice start to look for brokers and get the quick overview of what’s available, have a look at http://www.100forexbrokers.com/.
We feel we’ve covered a lot of ground here, and you might be more confused now than you were when you first started reading this article. We apologize if that’s the case and we’ll try to sum it up for you below by giving you some pointers when selecting a broker.
Here’s the beef of what we consider important when selecting brokers.
Quick Broker Selection Checklist:
Examples that would fit this profile:
We use PepperStone and The Collective FX on all our live accounts and recommend using PepperStone if you’re looking for a good trustworthy broker.
Another good broker is FinFX but they’re not (yet) officially registered in Europe.
As a final note: Do your own due diligence..! Google for the broker. Read feedback on forums. Participate in discussions. Demo the EAs for a while on the broker platform and compare results with those shared on forums or on sites that track accounts (MTI, myfxbook.com, etc).
We hope we shed some light on the difference between brokers and the impact brokers can have on your live trading results. So next time you’re wondering why you ‘did not get that trade’ and your trading buddy did, you might want to investigate your broker a bit more…
As one of our TulipFX team members always says: “You can get a Porsche, but what good does it do if you can drive it on a dirt road only?”
Wishing you all the best in your trading, and we hope we clarified some things for you!
Dutch & Ozzie.The Impact of your Broker Choice on your Trading Results,