Are You Asking Your Forex Dealer the Right Questions?

11/03/2010 12:01 am EST

Focus: FOREX

John Jagerson

Co-Founder and Contributor, LearningMarkets.com

Recently, there have been changes made to the regulatory and capitalization requirements needed to be a forex dealer. The intent of these new regulations is to help reduce the prevalence of poorly run, over-the-counter forex dealers often called "bucket shops." Currently, the net capitalization requirements have been increased to $5,000,000 minimum and many traders have re-evaluating their dealer based on those new requirements.

Capitalization is only one of many ways that a forex dealer can be evaluated. Performing "due diligence" on a broker or dealer is important because the failure of one of these firms can be catastrophic to a trader's account. The mere mention of the firm Refco is enough to send shudders down the spine of most traders. What else can be done to increase your confidence about a particular broker or dealer?

This is part of a live webinar I gave previously on the process of doing due diligence on a forex dealer, although the same process could be applied to stock and option brokers as well. Besides capitalization, I will cover how to research a firm for complaints and compliance issues. I will also show you how to find information about the individuals who you speak with from your broker, as well as other service providers like IBs or system sellers.

The growth in the forex market and its relatively open regulation has created an environment where very innovative products and dealers can flourish. However, it has also created opportunities for companies that are run without proper controls and that may pose a risk to your account.

Doing some simple due diligence on your broker or dealer can help reduce the risk that you will run into one of these bad firms yourself. There are a few specific suggestions that I will make in the video that can help you make a good decision when you are choosing a dealer. This research is not only helpful when choosing a dealer; it should also be repeated on a regular basis to check up on your dealer as well.

1. Check the registrations and complaints records. In several jurisdictions, there are easy-to-use public records (such as the BASIC system run by the NFA in the United States) that can be used to make sure your prospective dealer is registered correctly and does not have unexplained complaints lodged against them. If these records don't exist for your dealer, it is one more unknown risk you will have to decide whether or not you will live with.

2. Watch capitalization requirements. Most dealers in the major markets must meet minimum capitalization requirements. This helps create a barrier to entry for some of the "bucket shops" in the business. The information is easy to get and to check up on at regular intervals.

3. Good reviews are available, but you have to be careful to avoid the hype and scams. Reviews of dealers do exist, but there are a lot of them that are merely marketing scams. Two that we have found to be very useful are ForexDataSource.com and the Readers' Choice Awards from Traders.com. These are available for low or no cost and the results may really surprise you.

4. Diversify your dealer. There is no reason that you have to get "married" to only one dealer. In fact, the principles of diversification apply here as much as they do to any other investing activity you undertake. Consider using more than one dealer so you have more flexibility and a broader experience.

The mistake that traders make is to assume that they have no choice but to take the word of their broker's sales representative. You have many resources available to you and should make dealer due diligence a priority before choosing a firm to open your account.

For a video John made with more information, visit LearningMarkets.com.

By John Jagerson of LearningMarkets.com

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