The number of retail traders has grown during the pandemic and many major brokerages have reported record growth in their profits, client deposits, and revenues.
While this is good business for the brokerages, the retail traders are now more at risk with the increased volatility in the markets and the rising number of scam brokerages targeting unsuspecting users.
Also, many young retail traders are now aggressively trading complex derivative products which is really risky. This had resulted in huge losses for traders in the past and prompted product interventions by major regulators.
Instead of getting swayed by promises, you should do your due diligence before choosing any brokerage, their products and watch out for red flags.
1. Unregulated Brokerage should be Avoided
Your broker should be regulated by appropriate authorities and licensed to carry out investment and brokerage business. By trading via a regulated broker’s platform, you are protected against bad practices by brokerages, which can include manipulation to outright scams.
The Central Bank of Ireland is responsible for licensing Financial Service Providers (FSPs) such as brokerages that offer trading and investment platforms in the UK. They also monitor the activities of these FSPs, to ensure consumers stay protected and are insured in the event the broker goes bankrupt.
You can find the list of registered FSPs and CISs on the website of the Central Bank of Ireland alongside the type of services they are licensed to carry out.
Similarly, in the UK, the brokers are regulated by the FCA. To know whether a particular trading or investment platform is regulated by the FCA, you have to check the firm/broker’s name on the FCA register on their website.
If the regulated broker goes out of business, then the investors are protected by the regulators. For example, there is CBI’s Investor Compensation Scheme that pays you up to 90% of your net loss, but not exceeding €20,000, should your broker go bankrupt.
The FCA also has in place the Financial Services Compensation Scheme (FSCS), to compensate consumers in the U.K. in the event their broker goes bankrupt. U.K. consumers can get compensated with €85,000 max.
2. Security & Two Factor Authentication (2FA)
One important consideration when choosing a platform is its security.
In recent times, fraudsters and hackers have devised ways to steal money via hacking these platforms or by manipulating users to send them their password. A platform that does not have an added layer of protection is vulnerable to such attacks. 2FA requires you to provide two pieces of information to identify yourself.
2FA combines something you know and something you have. It provides an extra layer of security and significantly reduces the vulnerability of a platform.
For example, you could activate 2FA for sensitive operations like linking a new account to your trading app. The way it will work is that when you access the trading app with your password and click on the link 'new account', a verification code will be sent to your mobile phone or email address.
It is only when you input this verification code, that the new account will be linked. The idea is that even if the hacker has your password remotely, he still needs the verification code which will be sent to you so he will be stuck.
By using a platform that has 2FA, you reduce the possibility of your account being hacked remotely by fraudsters.
If your platform is web-based such as Webtrader, you should ensure you use a safe browser and the connection to the broker’s server is secured via https. A secure connection will always have the padlock icon in the URL bar on your browser.
3. Broker Trust & User Reviews
Find out how long the brokerage has been in existence, and also find out how they compare with their contemporaries.
You also need to find out if the broker has been involved in controversies in the past. Many brokerages have parent companies behind them, who may have gone through name changes in the past for various reasons, so you need to do some investigation. This will help you determine how trustworthy or safe the platform is.
The broker behind the platform should have a history of transparency and should have been recognized with licenses from multiple regulatory bodies. For example, if the broker is also a publicly listed company or a major bank, this gives you an idea about their credibility and competence in handling your investment.
When you search a broker’s name, you will also find that there are several platform comparison websites that rank platforms based on specific criteria such as fees, risk management etc. But don’t blindly trust these websites.
Many 'affiliate' websites may likely earn commissions or kickbacks from brokers to send new customers. So, these websites are incentivized to put positive reviews of brokers they work with.
You should instead check the user reviews on platforms like the Play Store and App Store, which could give you an indication of the issues the broker has.
Brokerages that have been around for a long time are usually more capitalized and have a budget to take care of Information technology research and development.
A platform that is riddled with controversies and scandals should not be trusted to provide the needed safety of your funds.
4. Complex Products
Some of the products which brokers offer are very complex products that are suitable only for professional traders. Still the majority of brokers offer complex instruments like CFDs to retail traders.
Complex instruments such as CFDs or spread betting involve the use of margin or leverage. When you are trading CFDs or spread betting, you don’t own the underlying asset, you are speculating if that asset will rise or fall in value.
For example, spread betting is one such complex derivative product. This list of spread betting brokers highlights that the major brokers in the UK have max. leverage of 1:30 for retail traders trading forex, which is as per the leverage restrictions imposed by the FCA on CFDs and similar products offered to retail traders. But even by using a leverage of 1:30, your losses are magnified.
If you are betting that the exchange rates of GBP/USD will go up, but the price goes down by 3.33%, then you would have lost your entire capital because your position was leveraged. The broker would still make money from their commissions and spreads.
5. Segregation of Client Funds
A regulated broker is required to separate funds being used for the daily running of the office; that is operational funds, from customer deposits. The only time they should transfer customer funds into their operations account, is when they are deducting fees and commissions. This is to prevent insider abuse and also enables the broker’s accounts to be audited easily.
The story of Alpari broker in the United Kingdom is a case in point. In 2015 after Alpari became insolvent, clients’ funds in their segregated accounts were safe, and most of the clients were compensated.
By trading or investing with a platform where customer funds are segregated, you stay immune from any shock insolvency that might affect the brokerage.
6. Responsive Customer service channels
No matter how sophisticated a platform is, users must at one time or another encounter problems. It is the responsibility of the customer support, to ensure such problems are resolved quickly and peacefully.
The platform should have live chat service, email addresses, telephone numbers you can call etc. Their response time should also be short.
7. Find out those behind the curtains
A brokerage is as good as the people running it. No matter how good the structure of a brokerage is, it can be rendered ineffective by weak, incompetent leadership.
Try to look up the credentials of the Directors of the brokerage, whose platform you want to use.
One way to look up the director’s profile is via LinkedIn. Here you get to see their career trajectory and their achievements. If they have a good history and experience in the industry, it is an indication that the brokerage will be properly run.
8. Don’t ignore warning signs
If you see a broker that offers excessive leverage and promises a high return on your investment; then you should know that this broker is a scam.
The purpose of your broker is to only act as an intermediary between you and the other party I.e., the buyer and the seller. And broker acting otherwise is a red flag.