What To Consider When Comparing Forex Brokerages

The forex market is a great place for individual investors, large and small, to engage in thrilling, fast-paced and potentially profitable trades. But you can't participate in forex currency trading if you don't first have a forex brokerage account. While most stock-market brokerages allow you to also trade bonds, mutual funds, and other financial instruments, forex brokerage accounts are typically standalone entities. Here is what you need to know about opening a brokerage account.

Leverage

One of the major benefits of trading currencies is the tremendous amount of leverage even small-time traders are allowed. Typical leverage is 100:1, meaning for every $1 in your brokerage account, you can control up to $100 in currencies. A thousand dollars would thus allow you to control $100,000 worth of currency, so if the currency went up by 1% -- $1,000 -- you would actually double your money! But if the currency went down by just 1%, you would lose all $1,000 of your investment. What would happen if the currency went down by 2%? Well, theoretically, you would lose $1,000 above and beyond your initial investment, but in reality, a brokerage firm will usually step in and prevent this kind of loss.

Your main decision is what level of leverage to apply for. Leverage is given based on credit-worthiness, so if your credit report is pretty poor, you might want to pursue just 50:1 leverage -- which still gives you a lot of room to profit but limits your risk. Alternatively, if you have true nerves of steel and a real knack for forex trading, you may be able to apply for as great as 250:1 leverage!

Spreads

The good news is that there are no commissions charged on forex trades. The bad news is that, like stocks, forex currency pairs do have a bid/ask spread -- meaning a market maker will pay less for a currency than he is willing to sell it for. These spreads are extremely small, usually less than 0.05 cents, but the wider the spread, the more costly trading will be over the long run.

Not every brokerage has the same spreads, so it is important to review the typical distance between the bid and ask prices before selecting a broker.

Other Considerations

First and foremost among all other considerations are the currency pairs that a given brokerage deals in. For example, if you want to perform a Japanese yen for Swiss franc trade, you will need to find a brokerage that offers that currency pair. Virtually every forex brokerage deals in the main currency pairs -- the U.S. dollar vs. each of the following currencies: The Euro, the British pound, the Australian dollar, the New Zealand dollar, the Canadian dollar, the Swiss franc, and the Japanese yen -- but not all brokers deal in every possible "cross currency" pair (i.e. currency pairs that do not involve the U.S. dollar).

Finally, it's important to deal with a reputable broker. Currency trading is far less regulated than most other financial markets, and there are a lot of fly-by-night companies in the business. Be sure to investigate the company before sending them a check for a few thousand dollars -- it will be time well spent.