Forex trading has grown significantly, with a continued escalation in retail trading accounts since 2001. The retail forex industry experienced very light regulation in its early years, and stringent regulatory requirements have developed to protect consumers. When choosing a forex broker to work with, it is wise to verify the broker’s capital reserves before choosing to deposit funds and trade with it.
What is Forex?
The word forex evolved as an abbreviated way of saying foreign exchange, and it refers to the trading of currencies through a broker, where traders buy one currency and simultaneously sell another. These transactions happen in the over-the-counter market, which functions like the stock market. The forex market operates 24 hours each day, five days per week. The market is decentralized, with trading taking place over a network of computers in financial centers around the globe.
Businesses and institutional traders initiate approximately 5 percent of forex transactions, while individuals and speculators transact the other 95 percent through retail trading accounts. Retail forex trading has benefited from improvements in technology that allow individual investors access to increased amounts of market information, which has attracted more people to forex trading.
The National Futures Association (NFA) regulates capital requirements for forex firms based in the United States, in conjunction with the Commodity Futures Trading Commission (CFTC). Specific requirements for capital reserves are enforced by the NFA to protect consumers against a broker going bankrupt. Forex traders usually deposit a sum of money with a forex broker in order to open an account and start trading, with amounts ranging from $100 to $25,000 or more. Traders may also accumulate profits in their accounts over time.
Beginning in 2008, the NFA required forex dealers to increase their capital reserves in stages, ending with $20 million in net capital reserves for each forex broker by 2009. Few forex brokers in the United States could meet these requirements, and many were forced to close or relocate outside the U.S.
Check Up on a Broker
To check the current net capital reserves of a U.S.-based forex trading broker, the CFTC provides information on its website (see Resources). The more capital the firm has over the minimum of $20 million, the better it can protect its clients. For trading brokers based outside of the U.S., BabyPips.com published a list of regulatory bodies in an article titled “6 Most Important Things to Consider When Choosing a Broker” (see Resources). Europe, Hong Kong, Australia and Canada are strongly regulated markets with substantial capital requirements. However, forex brokers located in third-world or other countries may not have the same level of regulation.