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Example of Narrowing down a Broker

Here is a case study of my search for the "right" broker that suits my trading style and strategy. 

I have built a promising EA using a combination of moving averages and MACD to enter/exit trades on M15 time frame using a 100 pip stop and 50 pip take profit. I am thus a short term trend trader. Moreover, I am a US client wanting to select a broker from a US-based NFA Regulated firm. 

Ultimately, the broker I decide upon after a process of elimination via my own personal broker criteria is my own personal selection, based on the criteria important to me.

 My beginning filtering criteria was: 
  1. Only MT4 Brokers Regulated in the US
  2. A Very Tight and Competitive Spread + Commission
  3. Low Starting Minimum with Micro Lot Availability.  
  4. Back Office Solution to Non-Hedging (FIFO) Rule  
  5. Prefer STP or ECN but will also include Market Makers of good reputation.  
You may begin with any of the above criteria to filter out the brokers who will make the grade for you.

I will go now go through and explain each of the filter criteria I used, per the order I have listed them above.

Criteria 1: Only MT4 Brokers Regulated in the US

If you had read my article on Forex Regulation in the USA, you would see that I am no fan of the recent over-regulation of US Forex industry, particularly its no hedging (FIFO) rule, reduced leverage, and exclusion of gold and silver. I think that the Chicago Mercantile Exchange (who authored much of the Dodd-Franc Act of 2010), felt their futures products threatened from the competition with spot forex and gold, and used the 2008 financial crisis as an excuse to push their Washington cronies to grant extended power to their own CFTC guard dog, squeeze out forex broker competition with the $20M capitalization requirement, cripple the US forex broker business with unnecessary restrictions (such as max 50:1 leverage and zero hedging), and bully foreign forex brokers from accepting US clients.

However, as cynical as I am about power and greed as underlying motives behind specific types of governmental regulations or deregulations, I don't think all is black and white. While the forex industry was not the cause of the 2008 financial disaster, it had been growing at an exponential rate throughout the 2000s, and there had been a number of roguish firms and institutions stealing the fortunes and dreams of innocent investors in different forex related scams and ponzi schemes across the country. It is nice to know that the CFTC has been the sheriff in this "wild west" with a track record of putting an end to these bandits, and we are probably better protected from fraud by such an agency than without.

I had been an angered US client who had rebelled against the US regulations by opening up offshore brokerage accounts, even in jurisdictions that did not permit US clients (there are ways around it). But after my anger waned I noticed that things had worked out better than I thought: some brokers had worked out the no hedging rule in the back office, which permitted clients to freely hedge on the front end, and the 50:1 leverage restriction is easily tolerable if one sticks to smart money management rules of 2:1 leverage per trade. Moreover, the 20M capitalization requirement provides some level of safety for the client, in that it is less likely than a smaller firm to go bankrupt if it cannot safely offset the positions of its clients, if operating as a market maker type broker. Lastly, given the track record of the CFTC in hunting down roguish outfits and fining firms that unfairly manipulate the broker house in their favor, I believe it will be harder for dishonest businessmen to start new scam outfits, and it will be harder for existing firms to continue practice cheating tactics at previous levels (I think they they will always try to cheat at some level they can legally get away with). 

It is for the above reasons and the fact that it is a lot easier for me as a US client to open a US forex brokerage account than one offshore, that I am looking for a US forex brokerage. Since the 20M minimum requirement and regulatory oversight has made it difficult for forex corporations to become US Forex Brokerages, this criteria of looking only at US Forex Brokerages immediately narrows down the forex brokerage options to around 21. See my list of NFA Regulated US Forex Brokers here

Now, of these 21 US Forex Brokers, I am only interested in those that have MT4 platforms. Why? Because the MT4 platform is free, sophisticated, and best of all, the most widely used. Any platform that is the most widely used quickly becomes the most preferred because of the higher level of community file sharing and education that attends such popularity. When MT4 becomes a filter, I can drop four US forex broker firms (FastBrokers, InteractiveBrokers, OEC, and Tradestation) because they do not support MT4 as a platform. They may have interesting platforms of their own, and I was a loyal 10 year user of Tradestation, but in 2009 it became clear to me that the retail forex community had gravitated to MT4. So I switched. 

This narrows things down to 16 US MT4 Broker Firms to choose from: 

Alpari US FXDD
ATC FXCM
CitiFX Pro GFT
EasyForex ILQ
eToro IBFX
ForexClub MBTrading
Forex.com Oanda
FXSol PFGBest

Criteria 2: A Very Tight Competitive Spread + Commission

As discussed before, spread + commission should be a foremost criteria for choosing a broker and narrowing down a broker list according to comparative spread is a fast way of eliminating brokers with too fat a spread. Any system can be vulnerable to the spread over time: 200+ trades later in the system's life, the difference in spread can make the difference between a profitable system and one that struggles for life.

In my Look for Razor Thin Transaction Costs article, I produced a table criteria for the competitive spread pricing. The table lists the currency pair, spread + commission it should NOT be above, and the ideal average range it should be, during decent volume trading hours (3:00 am to 4:00 PM EST). For the sake of simplicity, let us just look at the average spread threshold and ideal average of three popular pairs (EURUSD, GBPUSD, USDJPY): 

Currency Pair Average Spread
+ Commission
NOT above
Ideal
Average
Spread +
Commission
EUR/USD
2 Pips 1.2
GBP/USD
3 Pips
2
USD/JPY 2 Pips 1.2

The above spread filter is decent enough but I think I can do better. 

I am going to create another spread filter which I am going to call my Spread Averaging Filter. It involves 4 simple steps:
  1. Tabulate average spread of top pairs: I'm going to tabulate the average spreads of the top three pairs for each broker, putting them in three columns. 
  2. Average the average spreads of top pairs: I'm going to take an average of these top 3 pair average spreads and put it in a fourth column. 
  3. Determine baseline average spread: I then take an average of the fourth column for all brokers compared. That last average is going to be my baseline for elimination. 
  4. Elimination from Baseline: I eliminate all brokers whose spreads are above the baseline. 
Let me walk you through it.  

1. Tabulate average spread of top pairs

Currently, there is no absolutely easy way to discover the average spread of US-only brokers other than going to one or more good spread tracking websites and extracting this information one by one. Putting all my research together on the average spreads of all MT4 US FX brokers, I constructed the following table: 

MT4 US FX Brokers: Average Spread of Top Three Pairs:
Broker EUR/USD GBP/USD USD/JPY
Average* 
Alpari US 1.6 2.5 2.0  2.0
ATC** 1.6
1.6 1.3  1.5
CitiFX Pro
1.6 2.3 1.9  1.63
Easy Forex 3.0           
4.0
3.0
3.33
eToro 3.0 4.0 3.0 3.33
Forex Club 2.1 2.9 2.2  2.4
Forex.com 2.1
3.0 2.1  2.4
FXSolutions 3.0 4.0 3.0  3.33
FXDD 2.3 4.2
2.0  2.83
FXCM 2.9 2.9 2.6  2.83
GFT 1.7 2.5
1.8  2.0
ILQ 1.1 1.9 1.0 1.33
IBFX 2.0 3.4 2.5  2.63
MBTrading** 1.4 2.3 1.6  1.76
Oanda 1.2 2.0 1.1  1.43
PFG 0.9 1.5  1.1  1.16
** I added the commission to the spread for ECN Brokers to get the true cost: 
ATC = spread + 0.8 pips RT; 
MBTrading = spread + 0.6 pips RT.

* The fourth column is:

2. Average the average spreads of top pairs for each broker.

It is my quick and easy way of sorting brokers by spread. As you can see the lowest average spread is 1.16 (PFGBest) and the highest is 3.33 (Easy Forex, eToro and FXSolutions).

But wait a second. I remembered something important. I have to back up a bit and revise the above table to include the cashbackforexusa.com rebates (note: cashbackforexusa.com rebates serve to significantly reduce the spread on partner brokers). 

MT4 US FX Brokers: Average Spread of Top Three Pairs (with CashbackForex Rebate): 
Broker Cashback
Rebate
EUR/USD GBP/USD USD/JPY Average 
Alpari US  0.4 1.2 2.1 1.6  1.63
ATC   1.6
1.6 1.3  1.5
Citi
 0.2 1.4 2.2 1.7  1.76
Easy Forex   3.0           
4.0
3.0
3.33
eToro   3.0 4.0 3.0 3.33
Forex Club  0.3 1.8 2.6 1.9  2.1
Forex.com  0.7 1.4 2.3 1.4  1.7
FXSolutions  0.5 2.5 3.5 2.5  2.83
FXDD  0.7 1.4 3.5 1.2  2.03
FXCM  0.7 2.2 2.2 1.9  2.1
GFT   1.7 2.5
1.8  2.0
ILQ   1.1 1.9 1.0 1.33
IBFX 0 .5 1.5 2.9 2.0 2.13
MBTrading   1.4 2.3 1.6 1.76
Oanda   1.2 2.0 1.1 1.43
PFG   0.9 1.5  1.1 1.16

You see how the cashbackforexusa.com rebate had served to reduce previously intolerable spread brokers to being a lot more tolerable. For instance, Forex.com had an intolerable average spread 2.4 that became a whole lot tolerable after the cashbackforexusa rebate at 1.7. 

3. Determine baseline average spread.

Now the average spread, when you add up the average spreads and divide by 16, comes out to 2.01. I can now proceed to eliminate all the brokers that are 2.0 or greater. 

4. Eliminate from baseline.

With an average baseline spread of 2.0, I can eliminate all brokers that are 2.0 or greater.

In doing so, I can easily eliminate 3 fat spread brokers:
Easy Forex (3.33),eToro (3.33), FXSolutions (2.83). In my opinion, they are spread losers. Case closed. 

I can also eliminate 5 brokers that are slightly over my cut off line: IBFX (2.13), Forex Club (2.1), FXCM (2.1), FXDD (2.033), and GFT (2.0). These spreads are tolerable, particularly after the Cashbackforexusa rebate, but they are still not as competitive as I would like. 

With my spread filter, I have thus reduced 50% of the MT4 US Brokers, dropping from 16 to 8:
 
Alpari US ILQ
ATC MBTrading
CitiFX Oanda
Forex.com PFGBest

Now I'll proceed to eliminate a few more based my lot size preference.  

Criteria 3: Low Account Min with Micro Lot Availability

Ok, I admit, I don't have a lot of money to trade with. I am a middle class guy earning $50,000 per year, and over the last couple years, I managed to save $5000. This is not much. I am like most middle class people in that if I am laid off today, I can only pay the bills for 2 months out of my savings. I am then on the street. Most of this $5000 I keep in a bank account for rainy day type expenses, such as the emergency event that I am laid off work and need two months savings to survive. That does not leave me much disposable cash for trading purposes.

However, I think my EA is sufficiently promising to warrant a test run on a live account and so I have to decide the right amount to test it with, given my available savings. Since this is a relatively new, inexperienced EA, I don't want to risk all my $5000 savings on it. If I open an account with all my $5000 in savings on the extremely risky market where 95% of traders and systems die, I would be flagrantly over-capitalizing my account and setting myself up for losses I cannot afford. I do not want to under-capitalize either. If I open an account with a low $200 and traded with only a micro lot, I would be severely under-capitalized, as I would then be trading 5% margin on a 100:1 broker on any given trade (3% more than my smart 2% margin per trade policy). A stop out of 100 pips would incur a damage of $10, which would be 5% of my account, and if I had 10 such stop outs in a row, I would be down an insufferable 50%.  

I believe that $500 is a sufficient opening account (not too large, not too small), particularly if I trade with 1 micro (0.01) lot. With $500 and a micro lot, I would effectively be trading 2% equity per trade. Under the %Equity position size model, the size of my position is based on percent changes in equity, allowing for geometric growth of equity because the size of the position grows in relation to the equity growth of the account. The %Equity formula is:

Number of Units = (Equity / Lotsize) * %Equity

 Here is the $500 micro account wanting to trade with 2% of equity: 

Equity: 2%
Account Equity: $500
Lotsize: Micro Lot (1000 units)  

(500 / 1000) * 0.02 = 0.01 lots

I prefer to trade with 2% of Equity, which equates to using 2:1 leverage per trade, because it allows me to stay in the game longer. Using 2%Equity per trade on a $500 account forces me to use 1 micro lot. I thus have to look out for a broker with micro lot availability at the very minimum. 

Of the 16 MT4 US Forex brokers, three of them do not offer micro accounts, even though all three offer decent enough spreads:

ATC: Min Trade: 0.1 lots Min Account: $2,000 USD
CitiFX Pro: Min Trade: 0.05 lots Min Account: $10,000 USD
PFG Best: Min Trade: 0.1 lots Min Account: $1,000 USD

Eliminating these three from my remaining eight brokers narrows my list down to 5:

Alpari US ILQ
Forex.com MB
  Oanda

Most of my readers might just stop here and pick any of the above five based on criteria of their own. But I have two more filtering criteria that narrows things down for my own case.   

Criteria 4: Back Office Solution to the Non-hedging rule. 

Personally, I hate the non-hedging rule. There have been many apologists of the non-hedging rule arguing that hedging doesn't work, often using the example that it would be better to close out the position at a loss rather than open up a trade in the opposite direction to hedge the loss. I agree with that argument. However, what the apologists overlook is that the hedging rule prevents the possibility of working with multiple strategies on the same pair on the same account. This is most evident with EAs. When you have one EA that opens a short on EU, and another that opens up a long on EU, the non-hedging rule would prevent the second strategy from opening up its long trade. 

If you don't trade with EAs, or if you have only 1 EA per pair, you don't need to worry about the non-hedging rule. However, if you are like me who has 3 or more EAs working on EURUSD, and you want all three to operate without interference, then you have two choices: 1) you open up two accounts, one that takes only the long trades your EAs, and one that takes only short trades of your EAs; or 2) You either look for a broker who has worked out the non-hedging rule on the back office. It might not be a big deal to open up two accounts, but I prefer to open up one. 

Most MT4 US brokers out there do enforce the non-hedging rule on the front end, via the metatrader platform itself. It would issue out an error message when your second EA would open a trade in the opposite direction of your first EA. Only a few brokers managed to push back against the non-hedging rule by enforcing the rule in the back office, making it almost the non-hedging rule invisible to the client. This I like. 

Of the 8 competitive spread brokers, there are only 2 that offer the backoffice solution:

Alpari US ILQ

Note: FXDD has a back office solution but its spread is not competitive. ATC and PFG have back office solutions and they have competitive spreads, but they did not meet my criteria of having micro lot capability. 

Criteria 5: Prefer STP or ECN but will also include Market Makers of Good Reputation

I like the idea of an STP/ECN Broker. In the past it has been the successful scalper or news traders/EAs which has had their trades flagrantly manipulated (via spread widening or execution delays) by dealers or virtual dealer plugins installed within the market maker firm(ware). The STP/ECN execution models came about with increased demand for trades to be routed directly to the banks without interference, which was a necessary step for scalpers/news traders to be successful. However, my system is not a scalper or a news trader, and so it is not absolutely imperative that I must trade with a STP/ECN broker.

Is the spread any better with a STP/ECN broker? It is used to be that only the STP/ECN brokers offered the most competitive spread+commission. Before 2010, it used to be commonplace to see that most marker makers would offer 3 spread or greater on EURUSD, whereas only the STP/ECN brokers would offer something less than 2. But now the market makers have readjusted their spreads to be more competitive. In the last couple years I have seen the spread of all brokers drop dramatically, not as much as I would like them to drop but significant nonetheless. Sure, the STP/ECN brokers edge out over the market makers as a whole. Of the 8 US MT4 Brokers that offer the most competitive spreads, five them are STP/ECN brokers: ATC (ECN), CitiFX Pro (DMA), ILQ (STP), MBTrading (ECN), PFGBest (DMA). No STP/ECN broker in the US has non-competative spreads. The other three are market makers: Alpari US (with Cashback rebate), Forex.com (with Cashback rebate), and Oanda. There are eight other MT4 brokers in the US  less competative spreads and they are all market makers. 

Of the ECN brokers, ATC, CitiFX Pro,  and PFGBest had all been already filtered out because they have 0.1 lot size minimum, which is too rich for my blood. MBTrading has decent spreads, micro lot sizing, and is an ECN, but too bad it has not yet adopted the back office solution to the non-hedging rule. ILQ is the only STP broker with decent spreads, micro lot sizing and allows hedging.  

Of the market makers brokers with competitive spread and lot sizing, I have had to drop Forex.com and Oanda from my list because they did not offer hedging. That leaves me with Alpari US as the winner from the market makers. I am not prepared to exclude market makers from my list because I don't as of yet have a scalping EA that I must need a STP/ECN model to run upon. So Alpari US is still a strong contender next to ILQ. 

Summary

I developed a criteria specific to my own strategy and needs to quickly narrow the market place of brokers out there to a choice between two. Here is how my criteria quickly eliminated the bulk of broker choices. 

Broker Cut Brokers Left Brokers
Criteria1:
a) US Broker
100+
21
Criteria1:
b) MT4 
5
Fast Brokers OEC
Interactive Brokers Trade Station

16
Alpari US FXDD
ATC FXCM
CitiFX Pro GFT
EasyForex ILQ
eToro IBFX
ForexClub  MB
Forex.com  Oanda
FXSol PFG

Criteria2:
Competitive
Spreads
8  
EasyForex  FXDD 
 eToro  FXCM
 ForexClub  GFT
 FXSol  IBFX
8
Alpari US ILQ 
 ATC  MB
 CitiFX  Oanda
 Forex.com  PFG

Criteria3:
Micro Lot
3           
 
ATC
CitiFX
PFG
5
Alpari US ILQ
Forex.com MB
  Oanda

Criteria4:
Allow Hedging
3  
Forex.com
 MB
 Oanda
2
Alpari US ILQ

Criteria5:
STP/ECN
0
Alpari US is a decent MM
2
Alpari US ILQ


The two brokers that are US based and MT4 compatible, and have low competitive spreads, low lot size, and back office enforcement of the non-hedging rule: Alpari US & ILQ. 

Feel free to use the above elimination and research methods for the selection of a broker that meets your own criteria. It takes a bit of work but it is not so hard once you follow the above process. Good luck.  

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