Lesson 5: Forex Broker Scams

As you’ve read in an earlier lesson in this module, some brokers are really out to get your money and are not afraid to get their hands dirty. 

These brokers rely on underhanded tactics to take some of your funds or maneuver you into an easily exploitable position. 

Forex regulators have made some of the more well-known forex broker scams, such as bid-ask spread manipulation and stop hunting, illegal practices. However, some of the methods that unscrupulous brokers use are technically legal. In such cases, avoiding them will be a matter of awareness. 

This lesson highlights some of these techniques and can hopefully protect you from falling for these schemes. 

Lesson Highlights 

• Some brokers act against the best interests of their clients to get more revenue. 
• Brokers can manipulate the bid-ask spread to gain more revenue per trade from their clients. 
• Stop hunting is an illegal practice where brokers or other larger market participants intentionally trigger the stop loss orders of smaller accounts to force them out of their positions. 
• Some brokers exploit the occurrence of slippage and widen their spreads on purpose. 

Manipulating the Bid-Ask Spread 

Many brokers – especially commission-free ones – rely on spreads to generate revenue. The bid-ask spread is a built-in “transaction cost” of your trades. 

The spread is expressed in pips and usually ranges from 2-3 pips per trade. This means that every trade typically costs you 2-3 dollars minimum, depending on your position size. 

As spreads are inseparable from trades, disreputable brokers sometimes increase their spread rates from the usual 2-3 up to as high as 7-8 pips per trade. 

These brokers will benefit from the higher spread rate as it significantly boosts their revenue. This is especially true for brokers with a large average daily trading volume. 

Imagine this: the broker makes 7 dollars for every trade on their platform. The average day trader makes 10-100 trades daily, depending on their strategy. 

If the broker has a client base of 100 day traders who each make 50 trades per day, it will make a total of $35,000 every day from the spreads alone. With a 1000-trader client base, the broker’s daily revenue from spreads will be a whopping $350,000. 

Stop Hunting 

Careful traders often rely on stop loss orders as a reliable risk management measure. As platform providers, brokers know where these traders place their stop loss orders. 

This information gives dishonest brokers an opportunity to use the safety measures of traders against them – in an insidious practice known as stop hunting. 

Brokers engaging in stop hunting intentionally trigger their clients’ stop loss orders to drive them out of their positions. Doing this benefits brokers as their clients’ positions are forced to close their trades at unfavorable prices. 

The large volume of trades being closed also creates additional market movement, increasing volatility and giving other market participants a better entry position. These new players are often large financial institutions that coordinate with brokers in stop hunting. 

Exploiting Slippage 

Slippage occurs when your trade executes at a different price than you intended. For instance, you may place an order to exit a trade at a 1.5001 market price. However, various factors can prevent the timely execution of your trade. 

Whether due to substantial platform latency, high market volatility, or some other reason, your trade instead executes at a significantly different price. 

While slippage can and does happen when trading, some brokers take advantage of this occurrence – often at the trader’s expense. Some brokers even intentionally widen spreads in volatile conditions to get more revenue from their clients’ trades. 

Always Conduct Due Diligence 

One of the best ways you can avoid being scammed by unscrupulous brokers is by doing proper research before trading on their platform. 

Conducting due diligence can help you assess a broker’s trustworthiness and determine if they have a history of operating against their client’s interests. 

The next lesson will teach you about the various agencies in the US you can turn to for help should you run into a problem with scam brokers.