What else? Understanding differences in financial regulations across countries can give you information that helps you assess more about your broker’s financial strength or vulnerability. For example, for an entity to offer foreign exchange (FX) from Switzerland, the entity must be a bank—which in practice required to have capital of around 20 mio CHF (23 mio USD). An entity based in Turkey wishing to offer full FX is required to have capital of around 25 mio TRY (12 mio USD), and in other countries, the capital requirement might be less. Is there a 1-to-1 correlation between how much capital a broker is required to have and how good the broker is? No, not necessarily. A related point to consider (also within the context of the country) is the business model of the prospective broker. Does the broker have a license to manage his own risk or does the broker have an agent license only (“A book”-only). “A book”-only might not be required to have as much capital as a broker licensed to manage his own risk.
In summary, it’s very important to look at the regulation and stability of the country of the broker(s) you are considering and the business model of the broker. If you understand and/or sense a strong degree of protection and a minimal degree of vulnerability (capital & political), then you are more likely to make a good choice.
Factor #2: Cost of trading transactions
FX brokers typically charge clients in different ways:
a) Spread plus commission
b) Spread only (all included)
These are the two common ways that the client pays for the privilege/service of using the broker’s environment to trade.
Which fee structure is better? Answer: there is no inherently better or worse answer. However, it is important for you to fully understand the structure, so that your decisions are based on logic, facts, and maximum relevant cost-input information.
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To further specify, some brokers prefer to enact a “spread plus commission” model in which their fee-structures show a very low spread (let’s say starting from 0.1 pips and up), plus a certain commission per million traded (or per ‘lot’, in which 1 lot = 100,000 units). In this formula, a pip is the smallest price change that a given exchange rate can make.
Other brokers prefer to include the commission within their spread and will show a higher spread. Brokers will typically choose the model they use based on several factors. One factor can be cultural. For example, in some cultures, the broker’s clients (traders) don’t like the word “commission”, and they just want to see a spread with no extra commission. It is ultimately up to each broker to decide what structure he will offer to his clients. Some brokers, in an effort to demonstrate flexibility and variety for their clients, offer different account types, spanning both type of fee-structures.
But here is the important thing for you, as a trader, to keep top of mind: it does not matter if you as a client pay “spread plus commission” or “spread only”. What matters in your decision-making is: “How much money will I be paying or saving at the end of the day by choosing one of these models over the other?”
Let’s look at a concrete example:
Let’s say that I open two accounts, using two different brokers from the same jurisdiction. (So, as far as regulation and Factor #1 goes, these are equal.)
Now, I entrust to both brokers. Broker ‘A’ offers me spread plus commission: let’s say he offers me a fee structure that has me pay an average on EUR/USD of 0.2 pips plus a commission per one million of 35 USD. This means I will pay a total of 70 USD (around 1 pip) to open and close a position. Now we add this 1 pip plus the spread of 0.2 pips, we have a overall cost of approx. 1.2 pips.
On the other hand, Broker ‘B’ charges me an average spread of 1.8 pips (a standard commission of the market) with no commission. This means that, all costs included, Broker ‘B’ is charging me 0.6 pips more than what Broker ‘A’ is charging me (1.8 pips minus 1.2 pips). This 0.6 pips (or 43 USD) equals an average of 21.5 USD more in total commission (one way trading) that I would be paying to Broker ‘B’, on the same transaction.