Ask most new forex traders if they know what an introducing broker is and the answer you get is usually a blank stare. If you want to get somewhere in any business, it really pays to be familiar with even the smallest of details. In the retail forex business, understanding the role of your forex broker can affect what strategy is most effective for you to employ.
So first let’s address the difference between a broker and an introducing broker. A Retail Foreign Exchange Dealer (RFED) is a liquidity provider who usually offers a trading platform, competitive spreads, and some free form of research or education. These are the dealers that everyone likes to blame for all their problems as I highlighted in a previous article here. They are your primary access to the interbank market. You press buy and they sell it to you and vice versa.
A forex introducing broker (IB) is an independent entity that is required to be licensed by the NFA in the United States. These brokers act as sales agents and introduce you to an RFED that they have an official relationship with. IBs are compensated through a part of the bid/ask spread that you pay when you trade on the platform of the RFED that you have been introduced to. IBs are not liquidity providers and do not take the other side of your trades so there is less of a conflict of interest. These guys are a little bit more on your side (some of them anyway).
So the question is: Why open an account through an IB when you can go straight to the RFED? It is in the best interest of the IB to provide a product or service that adds enough value to justify doing business with them. These companies pick up where the RFED leaves off. These are the brokers that you can form a relationship with and benefit from since they have to offer a better deal than the RFED that they are introducing you to.
How do IBs offer more value you ask? There are a number of ways:
Rebates: Some IBs will actually share part of their compensation with you which effectively lowers your spread. For example, if you get a .5 spread rebate that means for every trade you make, instead of paying a 2 pip spread, you are paying 1.5. These brokers usually send you a rebate check at the beginning of the new month.
Education: The more common value add is some kind of education, research or other online help such as a chat room. These services can be helpful depending on the ability of the broker. They usually provide more attention and more structure than an RFED in this area. You even have some websites who offer social trading abilities where you can follow other traders who appear to be successful. Be careful with these, you are better off learning how to do it yourself than following a “secret” strategy that appears to be working. You need to know how the strategy works in order to effectively judge if it is appropriate for your risk tolerance.
Tools: Another common value feature is the offering of special indicators, or even automated trading strategies. You want to watch out for these because one thing an introducing broker wants you to do is trade. When they are offering you a free automated trading program you seriously need to question the strategy because it may be one that is only meant to generate volume and is not to your prime benefit.
Most importantly you want to choose an IB that will guide you into a strategy that is practical at the RFED you are being introduced to. For example, if your IB promotes scalping, and introduces you to an RFED that is not giving you active trader spreads, you are already at a big disadvantage. Swing trading is more appropriate for regular retail accounts because spreads are usually too large to make shorter time frame trading practical.
NFA registered Introducing Brokers can be helpful if you choose one that is ethical and that you can trust. Always make sure to do your research on the NFA website and learn about their reputation. A good IB can offer you some guidance and structure that you will be lacking as a new trader. Even though this group does not have the best reputation in the forex world, you can still find a small group whose interests are more aligned with yours.
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Marc Principato, CMT
*No Relevant Positions
