Choosing A Dealer/broker

[عبدالله]

CHOOSING A DEALER/BROKER

Day trading in the cash/spot forex markets entails having an account with a brokerage firm that will facilitate the execution of your trades. The fact that the cash forex market in the U.S. is not regulated raises a number of confounding issues and risks in addition to the risk associated with market price movements. These issues revolve around the credibility, operational integrity, risk management, transparency, and marketing efforts of forex brokerages. But first, we need to realize that unlike the highly regulated exchange-traded markets, cash forex brokerage firms cannot be fitted into one single mold with regards to such issues and risks. One may divide such brokerages into four broad categories with distinctive features and attributes that make this market far from a monolithic industry.




GROUP 1

The first group includes large commercial banks, which in U.S. are regulated by the banking laws and regulations of United States, and offer the highest level of reliability. However, trading with such banks requires accounts of substantial size such as those of large and multinational firms, making them out of reach of day traders.



GROUP 2

The second group includes financial firms that function as a market maker for smaller brokerage firms and offer speculative trading opportunities to individual traders with trading capitals in excess of $50,000 or so. These companies are relatively few in number, but offer lower cost for trading and usually have a more solid financial backbone and operational integrity. But again, the $50,000 minimum account size makes them out of reach of most day traders.

GROUP 3

The third group includes small retail brokerages that cater to individuals who wish to risk only a small amount of capital, say only a few thousand dollars, just to test the waters as well as their luck or skill in trading. These small brokerages often work with a dealer or market maker in the second group for clearing their clients’ orders. This is where operational risks begin. Because of the larger minimum account sizes that the market maker requires of these brokerages, the operational set up of such an arrangement may be such that the local retail brokerage may combine the funds from all the accounts of their clients into one single account with the market maker in the name of the brokerage firm.

In such an arrangement, a day trader would call the in-house dealer in the brokerage firm to get a quote to enter or exit a position, and the in-house dealer in turn will call the market maker to get a quote. If the trader likes the quote, he/she will instruct the in-house dealer to enter a new position or exit an existing position, which the in-house dealer will do by making appropriate bookkeeping adjustments to the clients account. At the same time, however, and this is the crucial point, the in-house dealer will make a matching trade on their own account with the market maker.

So in theory, if the client's market call or trade is a good call, the client will make a profit (gross profit from the trade minus spreads and commissions) and the brokerage firm will also make a matching profit on their own trade with its market maker, which will be equal to the net profit they pay the client plus their own commission and perhaps a small spread. The loser in this trade is the market maker who would pocket a spread but would lose the gross profit on the trade made by the brokerage firm. Keep in mind that some brokerage firms charge the client a spread wider than the spread they pay the market maker (approximately twice as large), and this is a source of profit in addition to their commission although they may never disclose this to clients. Of course, if the client's call is a bad one, the brokerage firm will deduct the gross loss from the client's account and pay the market maker the net loss after taking out its own brokerage fees and commission. So, either way, the brokerage firm makes a commission and a small spread regardless of weather or not the client's trade is a winning or losing one; or so it is supposed to work, in principle.

In this kind of arrangement, lax operational procedures at the brokerage firm and irresponsible or foolhardy trades by some clients put a client’s funds at high risk. For instance, what if a client's trade loses much more than the outstanding balance in his/her account? Such a situation should not happen in principle because the brokerage firm must have put safeguards in place to stop a trade when the balance in the client's account approaches zero or preset limits. However, with operations run on a shoestring and with less skillful in-house dealers, such situations do occur.

Note that although a client's account might theoretically go into margin calls with the brokerage firm, the brokerage firm's own account with the market maker may not go into a margin call because that account has the funds from all other clients of the brokerage firm and thus in all likelihood the brokerage firm will not get a margin call from the market maker on time to stop losing trades. If the brokerage firm fails to spot and stop that losing trade on time in a fast moving market, that losing trade may drawdown the brokerage firm’s own account with the market maker—meaning that the brokerage firm may have to reach into its other clients' accounts to cover the losses. If the loss is significant, the firm may lose the equity in other client’s accounts and go bankrupt, even though those other clients were not involved at all in such losing trades.

That is one of the most significant operational risks associated with opening and trading an account in such an arrangement, even with a reputable small brokerage firm that typically has lax operational procedures and safeguards.

A logical question would then be how could a trader protect him/herself against such a mishap. First, take appropriate steps and measures to ensure that the subject brokerage firm is a legitimate entity. Ask for information on the market maker with whom the brokerage house is claiming to trade. Get specific information on the name under which they do business with the market maker and get a confirmation from the market maker. There have been instances in which a small brokerage firm claimed to trade with a reputable internationally known market maker, but after the principals of the firm disappeared with clients funds, the subject market maker denied ever working with or even knowing about that brokerage firm; a confirmation that should have been sought prior to opening an account with that brokerage firm.

Second, do a background check on the principals and the firm itself. If the firm has moved locations several times or has been conducting business under different names in a relatively short time, that is a warning sign. Brokerages solely operating in the cash forex market are not regulated (the vast majority of them are not even required to report capital gains or losses as well as interest income on client's accounts to the IRS), and thus barriers to entry are virtually non-existent. No licenses, qualifications or certifications are required, and anybody can set up a shop on a shoestring, as most of them have. They may disappear with clients' funds as fast as they came into existence.

Third, find out who will have the physical possession of your funds and whether or not your account is segregated from other clients' account and from the operating capital of the firm. Note that even if your account is segregated, it is no guarantee of safety because the operation of the firm as a whole may not be viable or may be questionable. But, if your account is not segregated, it is almost a sure sign of trouble down the road.

Fourth, find out if the firm will provide you with documented detailed tax information on your trading activities for the entire tax year. A simple profit/loss statement may not be sufficient to satisfy your tax reporting needs, and the chances are, this summary profit/loss statement is the most you can hope to receive from most brokerage firms and many of them would not even issue you such a statement. Consult your accountant (you may have to search hard to find an accountant who is knowledgeable about this particular market) to find out what specific documentation you would need for reporting your trading profits and losses for the year. Cash forex brokerages in the U.S. are not required to report to IRS, and thus a vast majority of them typically do not have accounting systems that can provide detailed reports of your trades. That means that you may have to manually fill all the details of each individual trade into IRS forms as are normally done for trades in futures. This would be adding an insult to the injury if you have had a losing year in your trades.

GROUP 4 (Bucket Shops)

This group is probably the riskiest and yet probably is more prevalent than most people realize. Many small forex brokerage firms operate as offshore corporations in U.S. and are popping up everywhere. Most of such firms may in essence be classified as fraudulent operations—they pretend to be an impartial and reputable brokerage firm and nothing more, but in reality they are their own market maker—a bucket shop—or are intimately affiliated with one, making them anything but impartial or reputable. Such a practice is illegal in regulated markets such as the commodity futures markets; but the forex market is not regulated. Their "market maker" is typically located in Far East, and their clients' accounts are supposedly segregated from other accounts for their protection. Such firms prey on unassuming and perhaps naive individuals who have limited or no prior knowledge of the forex market or trading skills.

Here is how their typical scheme works. They offer to 'train' you for free and teach you surefire trading tricks and skills that will easily make you incredible profits in a short period of time (they make it sound that returns of 5% per month is practically guaranteed) only if you open an account of several thousand dollars with them. Their training classes are normally taught over several hours by small-time or inexperienced traders or even by people who have never traded themselves (a successful trader would not be wasting his/her time teaching his/her tricks to some individuals who do not have a clue about what he/she is talking about).

In general, the material covered in such training sessions are watered-down versions of some of the more generic tools of technical analysis (formations of head-and-shoulder, double top, trend line, etc.) that could be found in any decent book on technical analysis. Their coverage of fundamental analysis, if covered at all, is a superficial coverage of some economic indicators and data published regularly—information which even seasoned traders and economists may have difficulty interpreting and acting upon. Again, such information may be found with much more depth and explanations in many well-written books on the subject matter. At the end of the training, they will declare you by decree a winning currency trader—never mind that even some big shot traders with years of experience at large financial institutions may not be able to generate 5% per month consistently without taking large risks.

The key question that you must ask yourself about this training is: If you are winning in your trades, who will be losing and why will they lose? Trading is a zero-sum game, and for you to win, somebody else has to lose. Who is that somebody else? If it is the bad luck of that somebody else that makes him/her lose, what makes you think that you have better luck consistently? If it is the lack of skill and knowledge on the part of that somebody else, what makes you think that you know more than that somebody else—you just got started yourself. After all, the information covered in the training is the generic information found in any decent book on the subject matter and anybody else has access to it. So, it certainly could not give you an edge over anybody else. Besides, if that information is so potent, why is the brokerage firm giving it away? The answer may lie in the fact that after all, they are a disguised market maker rather than a brokerage, and for them to win, somebody else has to lose. As it turns out, that somebody else who has to lose, in all likelihood, is you. Put it bluntly, their real incentive is to make you lose in your trade because that is the best way for them to make money!

They may tell you that they would help you make profitable trades in any way they can so that you would continue trading and they would continue making commissions. But, commissions are just pocket change compared to profits they make from your capital losses. The real show and pay off time for these firms begin after the training when you start trading. With the confidence and expectations of most trainees so high as to touch the clouds, many trainees begin trading with real money right away—after all, every technique worked so nicely in the examples discussed in the training, and trading looked so simple and easy.

The vast majority of these trainees begin to strike losing trades from the start, and after each loss, they may feel that they learned a valuable lesson that will make their technique more robust and their next trade definitely a winner. Some of these trainees quickly lose their investment and drop out while the more tenacious ones would add more funds to their accounts to get a second chance and to also make up for their losses. They eventually lose all their investment and move on with a bitter taste left in their mouth and a bruise left on their ego as well as their bank account. This is indeed the feast time for these firms as this is their bread and butter. They make their lion share of profit from the capital losses on these trades, not from the spreads or commissions they charge on trades.

Note that the trading losses that are supposedly going to the independent overseas market maker, in all likelihood, would be going to their foreign affiliate. (We have heard of stories that such an affiliate may actually not even exist—the phone calls by their in-house dealer is not to a bone fide and real market maker at the other end at all). In the income statement of their U.S. operation as an offshore corporation they may simply show a revenue generated only from commissions and spreads, but profits several times higher than commissions would go to their bank accounts overseas from their affiliate market making firms which collect your capital losses. Such an operation appears to be perfectly legal in the United States for the spot forex market is not regulated at the federal or state level in the United States.

Just to clarify this point, here is the rough and simple arithmetic of such a scheme for a $10,000 account. Let's assume that the brokerage firm charges $70 per round turn trade of which $20-$35 is paid out to the trader as his/her commission, and that interest paid or gained on over-night positions add up to a net of zero. Let's also conservatively assume that you enter only one contract at a time, which typically puts a $1,000 burden on your account, and that it would take 30 trades to lose your $10,000—in practice, most trainees lose their investment with only a few trades. These 30 trades would result in total commissions of $2,100, of which roughly $750 is paid out to the trader as commission, leaving the brokerage house net commission revenue of $1,350.

The remaining $7,900 is the capital loss on the account and would be collected by the overseas market maker as spreads and their trading capital gains. If the brokerage firm also gets back a portion of the spread charged by the market maker—a common practice which is never disclosed to you—the brokerage firm would also receive an additional $1,440, assuming 3 points or pips per transaction or 6 points per round turn trade and $8 per point. Thus, the total recorded revenue for this brokerage firm from your $10,000 account is approximately $2,800.

But, the capital loss that they collect through their overseas market making operation would be $6,450—a ratio of 2.3:1 for the capital loss revenue to commissions/spread revenue. In practice, this ratio would be much higher because it typically would take only a few trades by an inexperienced and unskilled trader to lose the entire account. So, you can now judge for yourself where their real incentive lies—expending their training resources to make you a winning trader so that they can continue to collect puny commissions while losing much larger sums of money to you through your winning trades, or tricking you to lose your funds so that they can collect your sizable capital losses in a very short time on top of the commission and spreads that they collect. Remember that being their own market maker means that they will lose money if you win in your trades. Does it make any sense for them to expend their resources to train you when doing so results in setting themselves up for major losses to you later when you enjoy capital gains in your trading?

Some state governments have taken some actions against such firms only after receiving wide spread complaints from defrauded investors. Some of these firms also have developed the bad habit of promising in writing 'guaranteed' returns to gullible investors contingent on opening large accounts and perhaps even letting some in-house 'expert' traders trade these accounts on the investors’ behalf. Such passive investment arrangements—or more appropriately called ‘passive speculation’—invariably end in large financial losses besides disillusionment and disappointment.

Lawsuits may then be filed against them and complaints may be submitted to state security and exchange commissions. When such complaints and law suites mount, making the continuation of the operation too risky, these firms often close their doors and go across the street to set up another bucket shop under another business name and under a different management or ownership name; but the cast of characters in this financial circus remains the same. They tend to disappear with as much alacrity as with which they popped up in the first place. Remember that they generally do not need to attain any special licenses, qualification or certification to open up their shop, other that the generic administrative licenses to operate as a business enterprise.

How can you protect yourself against such schemes? First, if it is an 'offshore' brokerage firm, it would probably be justified to question its legitimacy in this unregulated industry, given their track record and tarnished reputation. That is not to say that no 'offshore' brokerage firm in this industry can be viable, but that the odds are just against it.

Second, review the four guidelines highlighted for Group 3 brokerages. Third, do yourself a big favor, and paper trade real time for a while to test the ‘clever’ trading strategies that they taught you in their training classes. Fourth, if you still feel that you have developed enough knowledge and skills to trade profitably, start with a small account. Fifth, educate yourself as much as you can about the forex market as well as trading strategies before risking large sums of your hard-earned capital. See the ‘Capital needed to get started’ in FAQ for more details.

As always, consult your tax advisor and attorney before signing any agreements with a brokerage firm.

منقول

[محمدالسويد]

ماشالله عليك يا عبدالله ،هالمعلومة المنقولة من أحسن ما نقلت تصدق ان كل المكاتب في السعودية تعتبر من المجموعة رقم 4 وللأسف المؤسسة تاركة لهم الحبل على الغارب

[الفوركس]

ممكن توضح لنا ما كتبت بالعربي

[أسامه عبده]

الله يعطيك ألف عافيه أخوي عبد الله على هذي المعلومات القيمة

[عبدالله]

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محمدالسويد]ماشالله عليك يا عبدالله ،هالمعلومةالمنقولة من أحسن ما نقلتتصدق ان كل المكاتب في السعودية تعتبر من المجموعة رقم 4 وللأسفالمؤسسة تاركة لهم الحبل على الغارب

مرحبا باستاذي العزيز ابو عبدالله شكرا على مرورك وتشجيعك ،،،،،

وتصدق أني اول ما وصلت في قرايتي للمقالة الى المجموعة الرابعة تذكرتك على طول وقلت في خاطري ذولي اللي دايم ابوعبدالله يحذر منهم ...... البوكيت شوب ،،،،،

جزاك الله خير عن اخوانك المسلمين في حرصك استاذي العزيز ،،،

وعندي سؤال او استفسار ..... هل رفكو و FXCM يعتبرون من المجموعة الثالثة ام اني غلطان ....

وشكرا لك مرة اخرى

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الفوركس]ممكن توضح لنا ما كتبت بالعربي

مرحبا اخي الفوركس ......

السالفة وما فيها ان السوق في اربع مجموعات من الوسطاء

المجموعة الاولى : البنوك التجارية الكبيرة وهي تتعامل في الحسابات الكبيرة ولاتصلح لك كمتاجر يومي

المجموعة الثانية : المؤسسات المالية التي تعمل كصناع سوق وهي كذلك تتعامل في الحسابات الكبيرة ولا تصلح لك اذا كنت متاجر يومي . لان فتح الحساب عندها بخمسين الف دولار

المجموعة الثالثة : الوسطاء الصغار ( بالنسبة للمجموعتين السابقتين طبعا ) وهم ما تبحث عنهم للتعامل في الفوركس والكلام يطول عنهم ولنا ردة ان شاء الله عليهم .

المجموعة الرابعة : دكاكين السطول ( ابوسويد عطنا ترجمه لربعك ) ، نصابين ، غير مرخصين ، يتعاملون مع بنوك الافشور ، عاملين حالهم صناع سوق وهم خرطي ، وعودهم كذابة ، ربحهم من خسارتك ،

الله يعطيك ألف عافيه أخويعبد الله على هذي المعلومات القيمة

مشرفنا العزيز ... ابوعاصم ..... تسلم على مرورك .... وهذا بعض مما عندكم اخي الكريم ....