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Is Your Forex Broker a Scam?

If you do an internet search on forex broker scams, the number of results is staggering. While the forex market is slowly becoming more regulated, there are many unscrupulous brokers who should not be in business.

When you’re looking to trade forex, it’s important to identify brokers who are reliable and viable, and to avoid the ones that are not. In order to sort out the strong brokers from the weak and the reputable ones from those with shady dealings, we must go through a series of steps before depositing a large amount of capital with a broker.

Trading is hard enough in itself, but when a broker implements practices that work against the trader, making a profit can be nearly impossible.

Key Takeaways

  • If your broker does not respond to you, it may be a red flag that he or she is not looking out for your best interests.
  • To make sure you’re not being duped by a shady broker, do your research, make sure there are no complaints, and read through all the fine print on documents.
  • Try opening a mini account with a small balance first, and make trades for a month before attempting a withdrawal.
  • If you see buy and sell trades for securities that don’t fit your objectives, your broker may be churning.
  • If you are stuck with a bad broker, review all your documents and discuss your course of action before taking more drastic measures.

Separating Forex Fact From Fiction

When researching a potential forex broker, traders must learn to separate fact from fiction. For instance, faced with all sorts of forums posts, articles, and disgruntled comments about a broker, we could assume that all traders fail and never make a profit. The traders that fail to make profits then post content online that blames the broker (or some other outside influence) for their own failed strategies.

One common complaint from traders is that a broker was intentionally trying to cause a loss in the form of statements such as, “As soon as I placed the trade, the direction of the market reversed” or “The broker stop hunted my positions,” and “I always had slippage on my orders, and never in my favor.” These types of experiences are common among traders and it is quite possible that the broker is not at fault.

Rookie Traders

It is also entirely possible that new forex traders fail to trade with a tested strategy or trading plan. Instead, they make trades based on psychology (e.g., if a trader feels the market has to move in one direction or the other) and there is essentially a 50% chance they will be correct.

When the rookie trader enters a position, they are often entering when their emotions are waning. Experienced traders are aware of these junior tendencies and step in, taking the trade the other way. This befuddles new traders and leaves them feeling that the market—or their brokers—are out to get them and take their individual profits. Most of the time, this is not the case. It is simply a failure by the trader to understand market dynamics.

Broker Failures

On occasion, losses are the broker’s fault. This can occur when a broker attempts to rack up trading commissions at the client’s expense. There have been reports of brokers arbitrarily moving quoted rates to trigger stop orders when other brokers’ rates have not moved to that price.

Luckily for traders, this type of situation is an outlier and not likely to occur. One must remember that trading is usually not a zero-sum game, and brokers primarily make commissions with increased trading volumes. Overall, it is in the best interest of brokers to have long-term clients who trade regularly and thus, sustain capital or make a profit.

Behavioral Trading

The slippage issue can often be attributed to behavioral economics. It is common practice for inexperienced traders to panic. They fear missing a move, so they hit their buy key, or they fear losing more and they hit the sell key.

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In volatile exchange rate environments, the broker cannot ensure an order will be executed at the desired price. This results in sharp movements and slippage. The same is true for stop or limit orders. Some brokers guarantee stop and limit order fills, while others do not.

Even in more transparent markets, slippage happens, markets move, and we don’t always get the price we want.

Communication Is Key

Real problems can begin to develop when communication between a trader and a broker begins to break down. If a trader does not receive responses from their broker or the broker provides vague answers to a trader’s questions, these are common red flags that a broker may not be looking out for the client’s best interest.

Issues of this nature should be resolved and explained to the trader, and the broker should also be helpful and display good customer relations. One of the most detrimental issues that may arise between a broker and a trader is the trader’s inability to withdraw money from an account.

Broker Research Protects You

Protecting yourself from unscrupulous brokers in the first place is ideal. The following steps should help:

  • Do an online search for reviews of the broker. A generic internet search can provide insights into whether negative comments could just be a disgruntled trader or something more serious. A good supplement to this type of search is BrokerCheck from the Financial Industry Regulatory Authority (FINRA), which indicates whether there are outstanding legal actions against the broker. And if appropriate, gain a clearer understanding of the U.S. regulations for forex brokers.
  • Make sure there are no complaints about not being able to withdraw funds. If there are, contact the user if possible and ask them about their experience.
  • Read through all the fine print of the documents when opening an account. Incentives to open an account can often be used against the trader when attempting to withdraw funds. For instance, if a trader deposits $10,000 and gets a $2,000 bonus, and then the trader loses money and attempts to withdraw some remaining funds, the broker may say they cannot withdraw the bonus funds. Reading the fine print will help make sure you understand all contingencies in these types of instances.
  • If you are satisfied with your research on a particular broker, open a mini account or an account with a small amount of capital. Trade it for a month or more, and then attempt to make a withdrawal. If everything has gone well, it should be relatively safe to deposit more funds. If you have problems, attempt to discuss them with the broker. If that fails, move on and post a detailed account of your experience online so others can learn from your experience.

It should be pointed out that a broker’s size cannot be used to determine the level of risk involved. While larger brokers grow by providing a certain standard of service, the 2008-2009 financial crisis taught us that a big or popular firm isn’t always safe.

The Temptation to Churn

Brokers or planners who are paid commissions for buying and selling securities can sometimes succumb to the temptation to effect transactions simply for the purpose of generating a commission. Those who do this excessively can be found guilty of churning—a term coined by the Securities and Exchange Commission (SEC) that denotes when a broker places trades for a purpose other than to benefit the client. Those who are found guilty of this can face fines, reprimands, suspension, dismissal, disbarment, or even criminal sanctions in some cases.

SEC Defines Churning

The SEC defines churning in the following manner:

Churning occurs when a broker engages in excessive buying and selling of securities in a customer’s account chiefly to generate commissions that benefit the broker. For churning to occur, the broker must exercise control over the investment decisions in the customer’s account, such as through a formal written discretionary agreement. Frequent in-and-out purchases and sales of securities that don’t appear necessary to fulfill the customer’s investment goals may be evidence of churning. Churning is illegal and unethical. It can violate SEC Rule 15c1-7 and other securities laws.

The key to remember here is that the trades that are placed are not increasing your account value. If you have given your broker trading authority over your account, then the possibility of churning can only exist if they are trading your account heavily, and your balance either remains the same or decreases in value over time.

Of course, it is possible that your broker may be genuinely attempting to grow your assets, but you need to find out exactly what they are doing and why. If you are calling the shots and the broker is following your instructions, then that cannot be classified as churning.

Evaluate Your Trades

One of the clearest signs of churning can be when you see buy and sell trades for securities that don’t fit your investment objectives. For example, if your objective is to generate a current stable income, then you should not be seeing buy and sell trades on your statements for small-cap equity or technology stocks or funds.

Churning with derivatives such as put and call options can be even harder to spot, as these instruments can be used to accomplish a variety of objectives. But buying and selling puts and calls should, in most cases, only be happening if you have a high-risk tolerance. Selling calls and puts can generate current income as long as it is done prudently.

How Regulators Evaluate Churning

An arbitration panel will consider several factors when they conduct hearings to determine whether a broker has been churning an account. They will examine the trades that were placed in light of the client’s level of education, experience, and sophistication as well as the nature of the client’s relationship with the broker. They will also weigh the number of solicited versus unsolicited trades and the dollar amount of commissions that have been generated as compared to the client’s gains or losses as a result of these trades.

There are times when it may seem like your broker may be churning your account, but this may not necessarily be the case. If you have questions about this and feel uneasy about what your advisor is doing with your money, then don’t hesitate to consult a securities attorney or file a complaint on the SEC’s website.

Already Stuck With a Bad Broker?

Unfortunately, options are very limited at this stage. However, there are a few things you can do. First, read through all documents to make sure your broker is actually in the wrong. If you have missed something or failed to read the documents you signed, you may have to assume the blame.

Next, discuss the course of action you will take if the broker does not adequately answer your questions or provide a withdrawal. Steps may include posting comments online or reporting the broker to FINRA or the appropriate regulatory body in your country.

The Bottom Line

While traders may blame brokers for their losses, there are times when brokers really are at fault. A trader needs to be thorough and conduct research on a broker before opening an account and if the research turns up positive for the broker, then a small deposit should be made, followed by a few trades and then a withdrawal. If this goes well, then a larger deposit can be made.

However, if you are already in a problematic situation, you should verify that the broker is conducting illegal activity (such as churning), attempt to have your questions answered, and if all else fails, and/or report the person to the SEC, FINRA, or another regulatory body that could enforce action against them.

Exploring Scams Involved With Forex Trading

While foreign exchange (forex) investing is a legitimate endeavor and not a scam, plenty of scams have been associated with trading forex. As with many industries, plenty of predators exist out there, looking to take advantage of newcomers. Regulators have put protections in place over the years and the market has improved significantly, making such scams increasingly rare.

Foreign exchange trading involves the trading of pairs of currencies. For example, someone might exchange euros for U.S. dollars. In September of 2020, 1 euro ranged in value from about $1.09 to about $1.12. So, a trader who exchanged 100 euros for $112 when the value of the dollar is high could profit by exchanging those $112 for euros when the value of the dollar drops back to $1.09 per euro. Such a transaction would result in a net profit of less than 3%, which likely would be wiped out by the broker’s commission.

Forex is a legitimate endeavor. You can engage in forex trading as a real business and make real profits, but you must treat it as such. Don’t look at forex trading as a get-rich-overnight business, no matter what you may read in hyped-up forex trading guides.

Exchange rates are volatile and can go up or down unpredictably. When accounting for commissions brokers take from transactions, making money requires significant changes in exchange rates in favor of the trader. High profits are possible, but it’s not a market where anyone should expect quick and easy cash.

What Makes a Scam?

Forex trading first became available to retail traders in 1999. The first handful of years was wrought with overnight brokers that seemed to pop up and then close down shop without notice.

The common denominator was that these brokers were based in nonregulated countries. While some did take place in the United States, the majority seemed to originate overseas where the only requirement to set up a brokerage was a few thousand dollars in fees.

A distinct difference exists between a poorly-run brokerage, which isn’t necessarily a scam, and a fraudulent one. Even a poorly run brokerage can run for a long time before something takes it out of the game.

Some common examples of scams investors should look for include churning and brokers who simply underestimate risk. Churning involves brokers who execute unnecessary trades for the sole purpose of generating commissions.

Additionally, some brokers often overestimate the ability of investors to make a lot of money quickly and easily through the forex market. They typically prey on new investors who don’t understand that forex trading is what is known as a zero-sum game. When a currency’s value against another currency gets stronger, the other currency must get proportionally weaker.

How to Avoid Being Scammed

The first step to take is to check the location of the brokerage’s headquarters and research how long it has been in business and where they are regulated. The more the better.

If you feel you are being scammed, contact the U.S. Commodity Futures Trading Commission.

The simple act of finding out who you should call if you feel that you’ve been scammed, before investing with a brokerage, can save you a lot of potential heartache down the road. If you can’t find someone to call because the brokerage is located in a non-regulated jurisdiction, this is usually a red flag and a sign that it’s best to find more regulated alternatives.

How to Avoid Forex Trading Scams

The foreign exchange (forex) market is huge, with an average daily trading volume of more than $5 trillion, including currency futures and options. It’s also not very well regulated. That means the opportunity still exists for many forex scams that promise quick fortunes through “secret trading formulas,” algorithm-based “proprietary” trading methodologies, or “forex robots” that do the trading for you.

Before getting involved in forex trading, perform your own due diligence by visiting the Background Affiliation Status Information Center (BASIC) website created by the National Futures Association (NFA), the futures and options industry’s self-regulatory organization, to learn how to choose a reputable broker and avoid scams. Before dealing with the public, every company or person who wants to conduct off-exchange forex business is required to become a member of the NFA and to register with the Commodity Futures Trading Commission, the government agency that oversees futures and options trading. You can search BASIC to find out what regulatory actions, if any, have been taken against a particular individual or firm.

Signal Sellers

One of the challenges a rookie forex investor faces is determining which operators to trust in the forex market and which to avoid. Signal sellers are one group of operators to consider carefully.

A signal seller basically offers a system that purports to identify favorable times for buying or selling a currency pair. The system may be manual, in which case the user must enter trading info, or it may be automated to put through a trade when a signal occurs.

Some systems rely on technical analysis, others rely on breaking news, and many employ some combination of the two. But they all purport to provide information that leads to favorable trading opportunities. Signal sellers usually charge a daily, weekly, or monthly fee for their services.

A frequent criticism of signal sellers is that if it were really possible to use their system to beat the market, why would the individual or firm that has this information make it widely available? Wouldn’t it make more sense to use this incredible signaling system to make huge profits for themselves?

Other analysts distinguish between known scammers and more reputable sources of market information that offer a well-thought-out signaling service.

Behind these opposing views lies a larger difference of opinion about whether anyone can predict the next move in a trading market. This fundamental disagreement won’t be settled any time soon.

Nobel Prize-winning economist Eugene Fama proposes in his well-regarded efficient market hypothesis that finding these kinds of momentary market advantages really isn’t possible.

His economist colleague Robert Shiller, who’s also a Nobel Prize winner, believes differently, citing evidence that investor sentiment creates booms and busts that can provide trading opportunities.

The best way to determine if a signal seller can benefit you is to open a trading account with one of the better-known forex brokers and enter practice trades that don’t involve real money based on the signals. Be patient, and with time, you’ll determine whether predictive signaling works for you or doesn’t.

Phony Forex Investment Management Funds

In the past few years, forex management funds have proliferated. Most of these are scams. They offer investors the “opportunity” to have their forex trades carried out by highly-skilled forex traders who can offer outstanding market returns in exchange for a share of the profits.

The problem is, this “management” offer requires the investors to give up control over their money and to hand it over to someone they know little about other than the hyped-up and often completely false record of success available on the scammers’ website and brochures.

Investors often end up with nothing, while the scammers use investors’ funds to live high on the hog.

A good rule of thumb in the forex market, as with other areas of investment, is that if it sounds too good to be true, such as annual returns of more than 100 percent, for example, it’s almost certainly a scam.

Dishonest Brokers

Although the forex market is not entirely unregulated, it has no single, central regulating authority. The forex spot market, however, which accounts for the majority of trades, is completely unregulated. Unsurprisingly, some forex brokers do not deal fairly with their customers and, in some instances, defraud them.

Aside from searching the BASIC website, you can help yourself avoid a bad broker by dealing with one that also handles stock market trades and so is regulated by the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA). While the forex trade itself may be unregulated, a broker subject to SEC and FINRA oversight probably wouldn’t risk its license for other securities by defrauding its forex customers.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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