of investment schemes that promise significant returnswith little risk. You should take a close and cautious look at the investment offeritself and continue to monitor any investment you do make.
At the time of writing, third-party solicitors for retail spot forex trading were stillnot subject to regulatory oversight, and may make misleading statements and falsepromises to their heart’s content. A Google search on the term “forex” will quicklyreveal all kinds of scams and false promises made possible by lax governmentoversight.
OVERSIGHTNFA Compliance Rule 2-36(b)(1) states that:
No Forex Dealer Member or Associate of a Forex Dealer Memberengaging in any currency futures or options transactions shall cheat,defraud or deceive, or attempt to cheat, defraud or deceive any person.
However, one quick visit to the NFA, CFTC, or FSA (UK) websites reveals thatsome of the largest retail FCMs have been reprimanded for things such as:
° Claiming slippage-free execution, guaranteed fills on stop-loss and limitorders and price guarantees on market orders, when in fact the FCM didnot provide any of the above.
° In times of volatility, changing the execution trade price post-fact after ithad already been confirmed to customers earlier in the day.
e Continuing to advertise “slippage-free” execution even though they knewit was not possible.
e Advertising “commission-free trading”, implying that the FCM does notmake any money from the transactions.
e Employing nonmember third-party solicitors using misleading promotionalmaterials to solicit customers.
e Claiming that “customer funds are segregated and safe at all times” whenin fact they are not.!
"You can check your broker instantly using NFA BASIC (http://www.nfa.futures.org/basic).Don’t Trust Your FCM 45
 
Even if they do get caught, most firms are let off with a slap-on-the-wrist fineand never have to admit any guilt. The problem is that although it is a valuableinstitution, in the end the National Futures Association is a self-regulatory agency,and asking forex brokers to “self-regulate” themselves is like asking athletes toself-regulate themselves for steroid abuse. It is just not very effective.
The Commodity and Futures Trading Commission, on the other hand, is thegovernment-sponsored body that oversees all exchange-related activity in the US(FSA in the UK). These are the guys that send crooked dealers and ponzi schemes tojail, but their FX oversight is limited because of the spot market’s over-the-counternature. The CFTC is set up to regulate exchange-traded markets, so in FX they cando little more than enforce outright scams and fraud.
The one way that the CFTC and NFA have found to effectively push the smallerFCMs out of the market is by enforcing the minimum net capital requirements,which up until recently have been little more than a joke. Because the rise of theretail forex market caught regulators sleeping, loopholes in outdated 30-year-oldminimum funding regulation enabled new FX brokers to establish themselves withlittle, if any, capital. These fly-by-night outfits (often companies repeatedly created,and closed, by the same individuals) were opened with as little as $250 000 incapital, and could therefore not withstand even the smallest adverse turn of eventsbefore going under. Although this should have scared the daylights out of theirretail clients with millions of dollars in nonsegregated trading accounts, most ofthe time they were blissfully unaware of the consequences (until it was too late)due to a lack of awareness programs. The subsequent bankruptcy of several smallbrokers (that took their client’s money with them) finally led the government to raisethe minimum net capital requirement and begin to crack down on these woefullyunderfinanced operations.
As of now, the minimum net capital requirements have been raised to severalmillion dollars (see Notes section for the full regulation) and the once-nonexistentaudits have been stepped up dramatically. A futures commission merchant whois not in compliance with these requirements has ten business days to achievecompliance or immediately cease doing business and go into liquidation, whichstill leaves retail clients out in the cold. Slowly but surely this has begun to weedout most of the dangerously under-funded brokers, yet many more “borderline”brokers still remain. The only way to ensure the safety of your funds is to onlytrade with brokers who are well above their minimum capital requirements. FCMsare required to file monthly reports with the CFTC stating their current finances,but remember that since these reports are only audited once a year you are for themost part relying on your broker’s word.”
2A full version is available online: http://www.cftc.gov/marketreports/financialdataforfcms/index.htm.46 Beat the Forex Dealer
 
As of 31 May 2007, this was how the major FX brokers stood:
 
 
In good standing Borderline
FXCM $51 000 000 Money Garden (MG) $3 399 844GFT $48 000 000 Forex Club $3 304 000
Oanda $44 000 000 MB Futures $3 080 000
FX Solutions $20 000 000 GFS Futures & Forex $3 074 000Gain Capital $20 000 000 Nations Investments $1 699 000CMS $10 000 000 Velocity4X $1 587 000SNC Investments $1 565 000Direct Forex LLC $1 523 000FiniFX $1 464 000One World Capital $1 105 000Royal Forex Trading $1 102 000FXDD $781 000
 
The bottom line is that today’s retail spot FX market is the Wild West of theinvestment world, where virtually anything goes. Government oversight of sucha complex and fundamentally OTC market is very hard to implement, but if theshoddy dealings continue then look for much tighter regulations to be implementeddown the line, although the retail FX brokers will surely not go down without afight. In fact, FX brokers are raking in so much money these days (hundreds ofmillions of dollars) that they have even hired their own lobbyists to keep govern-ment at bay. You know you have hit the big time when you can afford to buy alobby!
DEMAND CHANGE
For the retail trader to get a fair shake, the deceptive dealings (long outlawed inmost other markets) must simply come to an end. How can the FX brokers defendtheir actions (some of which call for jail time in other markets) and continue to tellthe general public that intra-day FX trading is a great “investment” and deemingit “easy”? How can they continue to do business with people that solicit clientsthrough false marketing and fraudulent claims?
New regulation needs to be put into place that will guarantee transparency inpricing and safety of funds to the retail client, but it is up to the average trader toplant the seeds of change by complaining vigorously to the government authoritiesat the slightest hint of dishonorable dealings. We will all be in a better place oncea fair set of rules are adopted that lets both brokers and traders flourish. After all,fair dealings should be every broker’s duty, not choice.9Third-Party Services
 
The retail FX market’s rise in popularity has created a whole new side-industryfocused on providing a range of services geared toward the retail trader. Hundredsof companies now offer clients great money-making trading signals or programs,and hitherto unknown market participants have now suddenly become recognizedmarket “experts” eager to dispel their boundless wisdom to traders (for a fee, ofcourse). Needless to say, the actual services they provide leave much to be desired.
Let me put it this way: if you had a proven, money-making FX trading systemwould you sell it to the general public? If you had a proven system that accuratelypredicted winning lottery numbers, would you sell it for $50 a pop? Probablynot. Hedge funds and private traders spend millions of dollars developing andsafeguarding their trading systems, but you can still find hundreds of differenttrading programs for sale on the internet or trading magazines. Common sensetells us that these “systems” are probably not very good to begin with.
When looking at third-party providers, it is good to be more than a bit skepticalof their services. For example, if the “guru” you are looking at does not trade hisown recommendations, then what is his downside? If the results cannot be verified(note that simply posting them on a website is not verifying them!) then what isthe point?
IF THE SUBSCRIPTION IS FREE, HOW DO THEY MAKE MONEY?
To ensure that you are getting a fair shake, it is best to make sure that the “expert”or “system” has no relationship with any broker. A dead giveaway is them askingyou to trade with their “preferred” broker, which is just another way of saying thatthey make a pip or two out of every trade that you place. You want to steer clearof anyone making money from your trading, since at the end of the day they donot care if you win or lose money; they just want you to trade.
Looking around the internet I have also seen many “mentors” popping up, whooffer to show traders the ropes in exchange for a fee. Although the practice of48 Beat the Forex Dealer
 
mentoring has long been established in the markets, paying someone for this kindof service is simply a bad idea; all you have to do is understand their motivation.
When a new trader joins a firm he will pair up with a more experienced traderwho will teach him how to become a great trader. The motivation there is simple:they have a vested interest in seeing their pupils succeed because of the time andmoney they have invested in them, and the hope is that they make millions forthe whole company. Now compare that to mentors offering to teach you for a fee.What is their motivation? To make their pupils succeed or to simply generate fees?If this mentor/trader is so great, why is he teaching random strangers? The truth isthat before these guys became popular FX gurus, they were selling miracle broomson infomercials. In the real world, mentors choose their students, not the other wayaround.
The best mentors you can possibly find are friends or acquaintances whom youknow to be good traders, since they have verifiable results and their motivation isclear.
SCAMS
According to the CFTC, the amount of FX scams has skyrocketed in the last fewyears. This is a direct result of the increase in popularity of forex trading and thelax oversight by government agencies. A quick web search is enough to show thefull range of forex scams out there, some promising 1000 % return with no risk!Before entering into any investment scheme, every investor should regularly checkthe CFTC’s website and also make a point to regularly check www.futuresbuzz.comfor the latest industry news and FX scams.
THE GOOD GUYS
Therefore, if looking for a second opinion, who do you trust? There are manygreat analysts and third-party services out there; you just have to make sure youpick the right ones. A whole community of professional technicians, economists,and analysts exists to service the institutional trading industry, providing innovativetrading ideas or market advice. The difference is that they make their money throughtheir calls (reputation) not through your trading (by getting referral money fromthe broker). I have personally used several subscription services in the past, withvarying results, but have noticed that good services have a few things in common:
e First, they are not cheap. As the saying goes, you get what you pay for.° Second, they have a track record. Not just a cool website.e Third, they have real-world FX trading experience. They can be ex-prop
traders, dealers, treasurers, etc. Basically they know how the real FX worldThird-Party Services 49
 
works, and take into account the manipulation, aberrations, and “irrational-ity” that sometimes prevails in these markets.
° Fourth, there is a time and money-management aspect to their analysis.It is useless to tell the average trader that the euro will drop to 1.20 iffirst they have to go through 300 pip gyrations and wait for three months.Opportunity cost is a real cost for most traders with limited liquidity. Thelast thing you want to do is have your equity locked in a trade that is notmoving while bypassing other (maybe better) trading opportunities.
The bottom line is that every great trader has paid their “tuition” to the market,usually in the way of years and thousands of dollars. Don’t expect much from a$19.99 system. Success is the direct product of hard work and determination, andyou have to learn to trust your own analysis and trading skills. Remember thatself-confidence is a hallmark of all great traders.
RULE 1. Never take the advice of someone who is not willing to put moneybehind their so-called analysis. If they are not willing to take a hit, then whatis their downside to making a prediction?
RULE 2. Never listen to anyone “talking their book”. Most jokers on chatforums are sitting on positions deep underwater and are desperate to get out.Any advice they can possibly give you is losing advice and should be usedas a contrarian indicator if anything. Even the big names routinely talk theirbook. When Bill Gross of PIMCO (biggest bond trader in the world) appearson CNBC to give his views on the market, do you really think he is going tosay something that goes against his positions?
 10Fighting Back
 
If you are feeling discouraged having realized just how far the odds have beenstacked against the individual trader, rest assured that there are a few simple mea-sures that can be immediately implemented to gain back some of the lost ground.The brokers may have initially gained the upper hand, but they have by no meansleft the retail trader without recourse.
USE DIFFERENT PRICE FEEDS
If you use the same price feed on your trading platform and your charting appli-cations, then you are essentially trading with blinkers on. By limiting yourself toyour FCM’s artificially created bubble, you are giving up the power to becomejudge and executioner. Your stops may be run or you may trade off manipulatedprices, but you would never realize that the moves did not correspond to the generalmarket.
As a trader, you want to remain at all times objective and have as broad a viewas possible of the market, something that cannot be accomplished using a singlefeed. Having a second or third feed is your way of getting a “second opinion”on the market and gives you a way to confirm the price action. Your platformfeed should only be used for placing trades, but your strategy and analysis shouldrely on the purest, most unbiased price feed you can find. Most retail traders donot have the luxury of trading with a Reuters or EBS feed, but rest assured thatalternative sources can be found. Every trader should spend some time comparingdifferent feeds and charts to see how they perform in fast-moving markets whenretail platforms regularly freeze their prices (and notice that demo feeds are differentfrom live feeds). Having a stable and faithful charting application is especially vitalto all short-term traders.
Do a search for yourself and find one that suits your needs, but remember thatmost of these “informative” websites are actually run or sponsored by brokers, somake sure that you know where the price feed is coming from. It may be worth the52 Beat the Forex Dealer
 
added cost of subscribing to an independent and dedicated charting package, sincethe benefit of receiving an accurate picture of the market will more than offset thecost in the long run. Before choosing one, however, ask them who provides themwith their streaming FX data feed.
KEEP DETAILED RECORDS
The next thing that traders can do to gain back some of the lost ground is to keepdetailed trading records. The number one reason is that most slighted traders find itdifficult to take action against their broker owing to lack of evidence. Clients mayfeel cheated when their orders are not filled correctly, orders disappear from theirscreen, or when they find open trades suddenly closed, but it is all very difficultto prove. When you call your broker to complain you may state that “my orderdisappeared!”, to which they may reply “do you have proof?” This often turnsthe matter into a your-word versus their-word scenario, which is why it becomesimperative to keep good trading records.
An easy way to do this is to take screen shots. You can find and downloada variety of applications on the web, and taking screen shots of your orders inthe market, trades, or any other important market activity (like unlawful pricespikes) gives you a solid foundation on which to argue any future disagreement.Professionals do it and so should you.
OFFICIAL ACTIONS
If you feel you have been wronged and cannot come to a suitable agreement withyour broker, do not hesitate to contact either the CFTC or the NFA. Although mostbrokers will usually fold when threatened with official action, if they instead chooseto call your bluff go directly to these agencies since both offer programs that mayhelp clients resolve disputes with brokers. You do not need to hire a lawyer to filea complaint, and usually taking this initial step is enough to scare a broker intoa (reasonable) settlement, since the last thing they want on their official record isanother disgruntled trader.
The NFA offers an arbitration program to help customers and NFA Membersresolve disputes. Information about NFA’s arbitration program is available by call-ing NFA at 800-621-3570 or visiting the Dispute Resolution section of its web siteat www.nfa.futures.org.
Similarly, the CFTC offers a reparation program for resolving disputes. Ifyou want information about filing a CFTC reparations complaint, contact theCFTC’s Office of Proceedings at 202-418-5250 or visit the CFTC’s website atwww.cftc.gov.
In addition, if you suspect any wrongdoing or improper conduct by your FCM,you may file a complaint with the NFA and CFTC by telephone or online:Fighting Back 53
 
www.nfa.futures.org/basicnet/complaint.aspxwww.cftc.gov/ent/enfform.htm
Your broker is banking on the fact that most clients do not go through the hassleof reporting their bad habits, so do everyone a favor and contact the authorities ifyou suspect suspicious activity. In the end, it is up to traders to monitor and stayon top of all forex brokers.
TRADE WITH THE CME
If you are fed up with your broker’s obnoxious habits, an obvious alternative totrading with an off-exchange broker is to trade through an exchange. The ChicagoMercantile Exchange operates its own clearing house and virtually eliminates creditrisk by acting as the counterparty to every transaction. An additional benefit to theindividual is that your funds are held in segregated accounts, meaning that theyare protected in case of bankruptcy (unlike on-line brokers). Hedge funds andindividual traders have used the CME for years to transact their FX business, sotake a look at their FX offering and see if it is right for you.
OPENING A TRADING ACCOUNT
Make sure to check your broker first. Visit the NFA/CFTC/SFA websitesand don’t trade with any firms not under their oversight. Better yet, perform yourown due diligence and go visit their office!
Don't judge a broker's execution by their demo accounts. Demos aremarketing gimmicks meant to lure people into trading. The execution onyour demo account will be perfect, unlike when you go “live”.
Always remember that the cost of switching is low, but the cost ofstaying with an unfair broker is huge!
Use your trading platform ONLY to enter and exit positions
Constantly looking at your changing P/L will prove hard on your psycheand makes many traders enter/exit their positions too soon. Professionalsdon’t fix their attention on their P/L, but rather on the price action.
The blinking prices and constant swings in equity are used by brokersto distract the trader and amplify the gambling instinct. Try instead tothink of the moves in terms of pips, not dollars and cents.
 54 Beat the Forex Dealer
 
TRADING HABITS
Of course the number one thing traders can do to shift the odds in their favor isto become better traders. This sounds obvious, but it is true. It is much easier toplace the blame on bad dealers, systems providers, etc., than on yourself, and forall of the shoddy dealings a retail trader may receive, at the end of the day it isusually their lack of experience and/or bad trading habits that are responsible forthe miserable results.
The learning curve can be steep and uncompromising, and in this market thereis no free lunch to be had. All traders, even the most successful ones, have paidtheir “tuition” to the market and all realize that the key to becoming successfulis survival. Simply put, the longer you stay in the market the better your chancesare of turning into a great trader. For new traders this means establishing yoursurvivability in the market and for experienced traders it means not falling intobad habits.
Obviously, even with all of the sophisticated charting and analytical softwareavailable nowadays success is still extremely difficult to accomplish, and movingup the learning curve can take a degree of dedication, capacity, and motivation thatmany traders simply do not possess. This leads many retail traders to “outsource”the analytical work to a third party, which can prove extremely hazardous sincebefore you know it you find yourself blindly following the advice of some marketguru, expert, or system. If it were only so easy! The actual decision-making processis the hardest part of trading, so make sure that you keep a firm grasp on it.
Once we put aside all of the nonsense handed out by brokers and gurus, it istime to get into the meat of becoming a great FX trader. What exactly does it taketo post steady profits in this business? What trading rules do professionals adhereto? What FX tricks exist out there that can help improve your performance?
The second half of this book is intended to give active traders the informationand tools they need to survive in the FX market and begin developing their ownhabits and techniques that will turn them into successful traders. 
JOINING THE 10 %11Becoming a Great Trader
 
Anyone who has ever traded knows that it can be an exhausting psychologicalbattle that leaves you mentally and physically spent at the end of the day. Althoughtrading is not easy, many people choose to make it even harder for themselves bysimply jumping in without taking a second to understand the different styles andhow they relate to their personality. By trading “against the grain”, you are settingyourself up for a constant personal psychological battle (should I cut or stay) thatoften leads to bad decision making, losses, and unhappiness.
Matching up your personality with your trading style helps to minimize thesepersonal battles, and if you are a new trader, the first step should be to figure outwhat kind of trader you have inside you.
TRADING TO YOUR STRENGTHS
Assuming you think you have the skills and drive needed to become a great trader,figuring out what kind of trader you want to be (more than just a “winning trader”!)is a critical step that requires some personal reflection. Although this does notrequire you to travel to the Gobi Desert to find yourself, you should spend sometime figuring out what trading approach best suits your personality.
For example, if you feel you are patient, methodical, and can generally keepyour emotions in check, then you may benefit from trading on a longer time frameapproach. Do you prefer to play chess or video games? On the other hand, if youare a high-energy, impatient, and emotional individual, you may choose to tradeintra-day for the instant gratification it provides.
The difference between holding longer-term positions and going home everynight flat is more than just a technical one, since watching profits fly away duringmomentary retracements can prove more painful to some than taking small lossesintra-day. Needless to say, the best traders are completely detached and have abso-lutely no problem watching their P/L gyrate, but in reality they are few and farbetween.58 Beat the Forex Dealer
 
All traders, whether self-taught or not, must at some point ask themselves thisquestion: “Am I improving?” Answering this question honestly will save you amountain of heartache down the road, since it is of no use to waste valuable timeand money doing something that does not fit your skill set. If you feel that you areimproving (measured by your P/L), then stick with it. If after several years you donot see any improvement in your trading, then you must have the courage to call itquits. Some people make good architects, some make good traders; it is as simpleas that. I cannot make a jump-shot to save my life, so I make no pretension of anNBA career.
If, for whatever reason, you are set on becoming a trader, proper money man-agement is by far the most important factor in achieving success. When you thinkabout it, most traders spend most of their time trying to figure out when to trade,instead of how much to trade, which is surprising given that money managementis the only thing a trader can actually control!
There is no guaranteed way to make money (except collecting spreads), and eventhe best and the brightest are often wrong more than they are right. The marketis bigger than you, bigger than me, and definitely smarter than all of us. We arebound to be wrong and make mistakes, but proper money management techniquesenable us to weather sustained drawdowns and live to fight another day. Funnilyenough, the biggest public misconception about traders is that they regularly takehuge risks, when in reality great traders aim to minimize their risk relative to theirreturns at any given moment.
Whether trading a mechanical system or in a discretionary fashion, all tradersshould know beforehand how much they are willing to wager. Ask yourself: howdo I determine my position size? How do I set my stops? All too often traderschoose arbitrary numbers that have little to do with proper money management,and exit according to their “pain threshold” instead. Our innate fear of failure makesus place too much importance on not losing, rather than learning to manage ourlosses comfortably.
The good thing about money management is that it is easy to implement.Although good trading systems may be impossible to find, good money man-agement rules do exist, and the best way to see if your money management needstweaking is by looking at your results. For example, if your losers are substantiallysmaller than your winners, then you may want to consider taking slightly largerpositions. If you consistently post large winners and losers, you should considertaking smaller positions to mitigate the risk of ruin. Proper money managementmaintains the all-important risk — reward balance in check, and although your plansmay vary from those I present here, the bottom line of any system should be thesame: to minimize the chance of blowing-up. Long-term success in this businessis achieved by accumulating steady profits and occasionally hitting the home-runtrade, and the longer you stay in the market, the more times you get to swing atthe ball.Becoming a Great Trader 59
 
OVERLEVERAGE
Some years ago, Procter & Gamble blindly entered into a series of leveraged deriva-tive trades and discovered to their great surprise that leverage not only magnifiesgains but, more importantly, it also magnifies losses, in their case to the tune of$300 million. This incident brought to life the risks of leverage to the corporatecrowd, but retail traders are still all too often unaware of the inherent risks. Lever-age, or gearing, is a double-edged sword that should be used sparingly, somethingnot helped by the fact that retail FX brokers constantly extol the virtues of 200-1leverage. By making it seem that “with $1000 dollars you can control $200 000” isa good thing, they suck naive traders into the leverage trap, since constantly over-leveraging your trades is the equivalent of always driving at 100 mph...sooner orlater you are going to crash and burn.
Taking a $1000 starting balance, if you were to trade $200 000 in EURUSD, amere ten point move (a 0.1 % move) against you would translate into 20% of youraccount equity getting wiped out. In fact, just by entering the trade (spread), youwould already be down 6 % on the trade, which is much more than any permissibleloss. Trading position sizes this big in relation to your account size mean that youare essentially trading yourself into a corner, and any market noise is bound to wipeout your account. The brokers love this, of course, since it means easy money forthem. If you are overleveraging your trades, then you may as well be handing overyour cash to your broker.
Professional money managers generally use no more than two to five timesleverage, and the retail investor should definitely not use more than ten. To putthat in perspective, using ten times leverage on a $1000 account means that theprice would have to move 1000 points against you before your account is wipedout. That is a lot of room to maneuver, and it gives the trader greater flexibility.
FLEXIBILITY
Choosing the right amount of leverage is the first critical step in maintaining yourflexibility in the market, which is critical if you are to survive for the long-haul.Flexibility in trading means giving yourself options: options to enter a trade, to stayin it, and to exit. By becoming overexposed to any one position, you essentiallyremove options from your table until you are faced with an “all-or-nothing” trade,and in the FX world your survival is measured in days, not years.
Since the currency markets are not one-way streets, the normal gyrations of themarket mean that, given time, you will usually have an opportunity to get out of abad trade or enter a position that you may have missed. Most traders have had thefrustrating experience of getting stopped-out, only to see the market return back60 Beat the Forex Dealer
 
to your entry at some point later in the day. The only way to get around thesesometimes arbitrary market movements is to stay flexible and trade multiple lots.
By trading only one lot you are essentially making a 50/50 bet that the rate willmove in your direction. Besides not being very wise (it has a negative expectedoutcome when you take the spread into consideration), it is also not much fun. Youshould try to think of your initial entry as your toe testing the temperature of thewater in the pool. If you find out it is too cold, then you can sit it out, but if it isjust the right temperature, then you are free to jump right in. Trading small untilyou think you have all of the information and confirmation you need gives you theflexibility to properly position yourself for the move, or pull out with a small lossif your analysis proved incorrect. As you may well know, for some reason the FXgods see fit to test our mettle every time we enter a trade by moving the marketimmediately against us, but trading multiple lots means that our first entry does notbecome critical and we give ourselves a cushion while the market decides where itwants to go. Trading in this way also means missing out on far fewer trades whencompared to the all-in approach, since pulling the initial trigger becomes ratherpainless and makes the decision-making process much less stressful.
To properly trade multiple lots you must first calculate the total amount you arewilling to risk before you enter your trade. Again, different traders take differentrisks, but it is safe to say that the intra-day trader should not risk more than 1-2 %of their account size on any one position. This means that for a $10 000 account,your loss should never be greater than $200 on all lots combined. Look back onyour trading and see how big your losses typically are.