When you start trading, choosing the right forex broker will provide access to foreign exchange markets along with trading tools and a range of CFDs. Read on to find out how to assess trading platforms, currency pairs, and forex spreads in 2021.
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The global foreign exchange market (aka forex market) is the largest financial market in the world. The global industry is valued at $2.409 billion with a staggering $6.6 trillion dollars traded daily.
Put simply, forex trading is the buying or selling of one currency for another at an agreed-upon price. While many forex market participants are institutional investors like private and central banks, retail investor accounts can start trading online with few barriers to entry.
With forex markets open 24/7, and 170 different currencies to trade, many find the endless opportunities, trading strategies and potential profits of forex trading appealing.
When online trading, forex brokers provide retail investor accounts access to derivative products called contracts for difference (CFDs). While traditional currency trading requires you to buy and sell the physical asset, CFDs allow you to speculate on price movements without owning the underlying asset.
As well as currency pairs, many brokers will offer CFD products derived from other asset classes, such as commodities, shares, indices, and cryptocurrencies like Bitcoin.
Although foreign exchange markets consist of 170 different currencies, the fx pairs you can trade as CFDs depend on the forex broker you sign up to. Certain brokers offer hundreds of major, minor and exotic currency pairs, while others offer a smaller selection of frequently traded majors and minors.
When choosing a forex broker in the UK, there are many important factors to consider. There are many brokers that accept retail investor accounts, with some offering unique features suited to different trading experience, style and strategies.
Three of the most important considerations include:
Forex brokers follow one of two main pricing and execution models that determine the forex spreads you can trade.
When trading forex, the spread refers to the difference between bid-ask prices. As a forex trader, you want the lowest spreads possible.
Also known as market makers, brokers that use a dealing desk set their own bid-ask prices and use their own liquidity to fill your orders. When placing an order with a dealing desk broker, they act as the counterparty to your trade.
There are both pros and cons to market makers. While this type of broker offers better risk management tools, there’s a potential lack of transparency as market makers have full control over the spreads they offer and the profit of your losses.
Conversely, no dealing desk (NDD) brokers use external liquidity sources to determine bid-ask prices and fill orders. When you place an order with an NDD broker, it is directly passed onto liquidity providers with no dealing desk interference. As prices are sourced from multiple providers, bid-ask prices react to current market conditions such as volatility and liquidity.
A major benefit to NDD brokers is they often offer faster execution and tighter spreads than market makers, as they are purely acting as a bridge between forex traders and multiple top-tier liquidity providers.
NDD brokers use straight-through processing (STP) or electronic communications network (ECN) execution methods, or in some cases a combination of the two:
Forex brokers may offer one account type or a selection of trading accounts with varying spreads and features. There are two main pricing structures and trading account types – commission and commission-free.
These trading accounts allow you to trade forex spreads with no commission fees yet brokers widen the spread to compensate for their brokerage services. No commission accounts are offered by both the dealing desk and NDD brokers.
In the table below you can see that NDD brokers like IC Markets and Pepperstone offer the tightest no commission spreads. For social trading brokers like eToro, commission-free spreads are over twice as wide as Pepperstone or IC Markets.
Data taken from broker website. Accurate as at 04/06/2021
Forex traders can trade spreads that are passed on from liquidity providers with no markup. As spreads are not widened, brokers are compensated through a commission fee. Only NDD brokers and often referred to as Raw or ECN Accounts.
As shown below, commission spreads can vary significantly depending on the forex pair and broker. For currency pairs like the EUR/USD (Euro vs US Dollar) and USD/JPY, Pepperstone offers the tightest forex spreads averaging 0.16 pips + commission fees. Likewise, Pepperstone provides access to the lowest spreads for the GBP/USD at 0.40 pips, while Dukascopy the tightest for the AUD/JPY at 0.47 pips.
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As market makers set their own bid-ask prices, all trading accounts with dealing desk execution are commission-free. On the other hand, many NDD brokers that use STP and ECN execution often offer both commission and commission-free pricing structures and account types.
For example, Pepperstone, an ECN-style broker, offers two trading account types:
Experienced traders will prefer NDD brokers with tighter spreads and faster execution, while beginner traders will find commission-free spreads attractive as there is no need for complicated fee calculations.
As well as commission and commission free account types, certain brokers may offer:
The trading platform you choose to develop and execute trading strategies is key to successful forex trading. Different software is suited to different styles of trading, with some renowned for algorithmic trading or social-copy trading tools.
The three most popular trading platforms worldwide are MetaTrader 4 (MT4), MetaTrader 5 (MT5), cTrader. While many forex traders use these platforms for their automated trading capabilities, the advanced charting tools also enable you to conduct sophisticated technical analysis.
Proprietary trading platforms are well-suited to two styles of trading, being beginner traders or those wanting the unique features for copy trading, strategy development or risk management. For example:
As CFDs are complex instruments, online trading comes with a high risk of losing money. To ensure markets and brokers operate fairly and transparently, the Financial Conduct Authority (FCA) oversees operations in the United Kingdom.
The UK regulator is one of the strictest worldwide, requiring brokers to provide strict investor protections to reduce the high risk of forex for UK traders, such as:
Forex brokers offer various risk management tools to reduce the high risk of trading CFDs. The two key trading tools offered by nearly all online brokers are:
Other leading regulators include MAS in Singapore and ASIC for Australian forex traders.
If you live in the United Kingdom or Ireland, the Financial Conduct Authority (FCA) allows you to spread bet as an alternative to trading CFDs. Spread betting involves taking a specific amount of money for each point of price movement in the underlying instrument. Although spread betting is similar to CFD trading in many ways, the key difference is how profits are treated under UK tax laws.
Any profits made from trading CFDs is exempt from stamp duty but subject to capital gains tax (CGT), while profits from spread betting are exempt from both stamp duty and CGT.
Brokers that offer spread betting services to UK residents include Pepperstone, CMC Markets, IG, City Index, ThinkMarkets, FXCM and OANDA.
Whether you are a beginner trader or an experience forex trader looking to switch brokers, it is important to understand the pricing structure as well as the trading platforms and features available. When choosing a new broker, find out if spreads are commission free, and what other CFDs and risk management tools are freely available.
Justin Grossbard has been investing for the past 20 years and writing for the past 10. He co-founded Compare Forex Brokers in 2014 after working with the foreign exchange trading industry for several years. He also founded a number of FinTech and digital startups including Innovate Online and SMS Comparison. Justin holds a Masters Degree and an Honours in Commerce from Monash University. He and his wife Paula live in Melbourne, Australia with his son and Siberian cat. In his spare time, he watches Australian Rules Football and invests on global markets.