Like any other business, a Forex broker needs to be regulated. Consider you’re starting a new business, any business in any sector: you’ll need to go to different authorities, get your license number, obey laws, etc. The same is valid for a Forex broker. A Forex broker that is not regulated is not a legitimate business. Would you give your money to an entity that is not entitled to operate legally? Probably not, and this is what regulation really stands for: the legitimacy of a business.
Reasons for Trading with a Regulated Broker
When it comes to Forex brokers or other companies that offer financial services, a financial authority should regulate the business. This authority will step in if things go in the wrong direction. In the case of a Forex broker, if the broker goes bust, the financial authority will step in as there is a whole process when dealing with these situations. This is for the customer’s good and if the business is not regulated, there is no protection against such situations.
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Protection Against the Broker
Therefore, protection against the broker is the first reason why a trader should trade only with a regulated broker. To be more exact, the financial authority is there to help the trader if something bad happens with the broker. What can go wrong one may ask? A lot of things can go wrong and the SNB (Swiss National Bank) example from January 2015 is the perfect case study.
- SNB and the EURCHF Peg
For years, the SNB pegged the EURCHF rate to the 1.20 level. This meant that no matter the costs, the EURCHF could not dip below the 1.20 level. From a trading point of view, this was something unexpected, but not unprecedented. There are many other central banks around the world that peg their currency to some other currency, especially to the U.S. dollar. However, the SNB is not any central bank, as it is one of the most influential central banks in the world. In pegging the EURCHF to the 1.20 level, the SNB basically put a floor on the pair. But things in Eurozone deteriorated and inflation threatened to go negative. As such, the ECB (European Central Bank) was poised to cut rates and move them into negative territory, not to mention to embark on a bond-buying program (quantitative easing). Facing the ECB adversity, the SNB had no choice but to drop the EURCHF 1.20 peg. What followed was a nightmare for both brokers and traders. The move caused the whole FX market to move aggressively as the CHF has been bought by HFT (High-Frequency Trading) algorithms. There was virtually no market for the EURCHF pair all the way down to 0.85 area. Other CHF pairs witnessed similar moves, and brokers were faced with an extremely weird situation: they couldn’t fill client’s orders for the simple reason that there was no market. Therefore, by the time things calmed down a bit and dust settled, few brokers went busted as they were not having enough liquidity to support the SNB disaster. If the broker was regulated, the financial authority will step in and the process of distributing the segregated funds back to the customer’s starts. It may take a few months, but rest assure that everyone will get their funds back. After all, it wasn’t anybody’s fault but the broker and the financial authority makes sure customers are not suffering alongside the Forex broker. This way, traders were protected against the possibility that the Forex broker will default.
Proof that the Broker is a True Business
A brokerage house has many potential sources of income: commissions from every trade, spreads, and even profits made from trading against all or some of the clients. There is nothing wrong with that, as, after all, a brokerage is not a charity. How can traders know that a broker is a regulated one? There are a few things that can be done.
Check the Webpage
The first thing to do is to check the web page for details regarding regulation. These details are to be found usually on the “Home” page, or “About Us”, or something like this. Regulated brokers are proud of that and will try to make it as visible as possible. Therefore, you should not find it difficult to dig the information as it will be placed in a visible spot. If it happens that you’re having troubles finding what kind of entity regulates the broker and there’s no license number to be seen, you should start questioning yourself if this is a broker you want to trade with. A regulated broker strives for transparency and will have all the data easy to find on the website.
Google the License Number
If the license number is not displayed, but the broker claims its business is regulated, the next thing to do is to look for the license number with the financial authority. This should be displayed on the website, but many brokerage houses fail to do so. A simple Internet search will bring the information needed. If this fails, the broker has some serious question marks. Moving on, ask on the live chat for the license number. If provided, inquire on Google or other search engines for more details and even ask the financial authority if that information is correct. While all these steps seem to be unnecessary, it is important to know as much information as possible about the party you’re handling your funds. No one says being suspicious is a wrong thing, but being careful is the right thing to do when it comes to your money. This article’s aim is to state the importance of trading with a regulated broker as a financial authority is also a reactive one. If a license is being given at the start of activity, it doesn’t mean it is there forever, as a broker’s license can be suspended. As a matter of fact, brokers are obligated to announce all their clients if the license is being suspended. This can happen for various reasons, but mainly because the broker is no longer meeting the requirements of being regulated and in turn, clients may suffer. To avoid that, the financial authority suspends the license. This is a very bad sign for a broker’s business and regulation as from this moment on trust is lost. Without trust, there is no business when it comes to Forex trading. The sooner brokers and traders understand that, the better.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market. - Why Trading Forex?
– Advantages and disadvantages of trading the currency market, what are trader’s expectations and what is a realistic approach to follow - What Makes a Good Forex Broker?
– Explaining what a good Forex broker is and how to recognized the scam brokers. Information about Forex brokers regulation. - Financial Products to Trade
– Different categories of financial products that a Forex Broker is offering for the retail clients, starting with the classical currency pairs, and continuing with commodities, CFD’s, indexes, etc. - Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc. - Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
Other Educational Materials
- “III. Special feature: Market liquidity and stress: selected issues and policy implications.” Borio, Claudio. BIS Quarterly Review (2000).
- Hedge funds, hot markets and the high net worth investor: A case for greater protection. Parry, H., 2000. Nw. J. Int’l L. & Bus., 21, p.703.
