Incorporates a full review of Darwinex
(post updated 10 May 2016 to reflect updates and changes since original post)
My intention from this article is to help other traders avoid the mistakes that I made, and to help good traders benefit from their efforts – trading is hard enough, without a stacked deck of cards working against you. This article provides a template and process that anyone can use to help them select a broker that is right for them, ensuring that they cover off all important criteria during the evaluation process.
It’s always good to use real examples to explain concepts and so I have chosen to use specific details from my broker, Darwinex who I’ve now been with for about two years. Darwinex is the trading name of the broker, but their registered company name (including that registered with the FCA is 'Tradeslide Trading Tech Limited).
And so in addition to this article providing a template to help you choose your next broker, it also incorporates a full review of Darwinex – a review that I believe is the most comprehensive and all-encompassing review of this broker available on the web currently (although I’m happy to be corrected if you find anything better). Later in the article I also explain the unique proposition Darwinex has that really sets them apart from other brokers – one that will help you realise your full potential and be able to trade for a living.
This is a longer article than I would usually write, but please stick with it. This is such an important topic and the decisions you take really can make the difference between whether you succeed or fail.
Criteria #1 - Broker Execution Model
- Dealing Desk - If the company is operating a ‘dealing desk’, then your trades never see the open market – instead the ‘broker’ themselves takes the opposite side of your trade. You broker doesn't disclose any information about your trade to any external person, institution, bank, or trading floor. Nobody other than your broker themselves are even aware you have made the trade. Is this such as problem you might wonder? As long as your trade gets filled why should you care? Well the problems start because of a conflict of interest. Under this model, if you win $1, your ‘broker’ loses $1. Conversely, when you lose money on a trade, your ‘broker’ wins. You notice I have put the word broker above in quotes. This is because they are not actually operating as a broker for your trades at all. They are effectively betting against you. Think of the book-maker at the horse races who takes your money on a race. When you win, he loses. The dealing desk model is pretty much the equivalent.
Now because this conflict of interest exists, there is a propensity for unscrupulous behaviour. Price spiking, stop hunting, and re-quotes are examples of the behaviour that I have, and I’m sure many of you have experienced in the past when dealing with a company using this model. How frustrating is it to have a spike take out your stop only to then see price go in favour of your trade? Why this isn’t illegal I have never understood, but it isn’t. But for as long as it isn’t, traders need to be absolutely sure they do their homework and avoid this model at all costs.
- DMA Broker – This model of 'Direct Market Access', is where the broker gets the best possible 'bid' price from the open market and the best possible 'ask' price, and offers these through to your trading client. When you then click buy or sell, the trade request is passed out for fulfilment on the market. The broker does not take the opposite side of your trade. As a result, the spread will continually fluctuate throughout the day, and on occasions will even reach zero (unless the broker is adding a margin to the spread). Note, that any company that is offering fixed spreads (e.g. “EURUSD spread of 0.8”) is NOT operating a DMA model. They are manipulating the spread internally as part of their dealing desk model. In a DMA model, the broker is NOT taking the opposite side of your trade and so it is in their interest that you succeed as a trader. The conflict of interest that the dealing desk model has, does not exist with a true DMA broker. They want you to be successful in the long term, and want you to continue being a customer.
There will of course be exceptions where the dealing desk model is used more ‘ethically’, without the dubious practices of stop hunting etc. but for me personally, this model comes down to the fundamental issue that the dealing desk is not aligned to your goals as a trader (you win, they lose), and that for me is a big no-no. In a nutshell I think it is fair to say ‘Dealing desk bad – DMA broker good’.
Now there are some brokers that want their cake, and eat it by running a hybrid model. They will have algorithms that assess your trading activity and effectively allocate you a score. If you are below a certain score they will use the dealing desk model, and if the trader is good, they don’t want to be on the wrong side of their trades, and so they will pass the trades they make out to the open market. My advice is stay clear of these also. This sounds to me like Russian roulette and isn’t a trading environment I’d like to be a part of.
Of course because dealing desks have had quite a bad press over the past few years, this has led to some dealing desks ‘coming good’ and converting over to a DMA model. Others however have chosen instead to attempt to ‘cover up’ the fact that they use this model, with complex words and phrases on their websites and marketing materials, and certainly by omitting to use the phrase ‘Dealing Desk’. Sometimes you will need to read between the lines and deduce what is really going on behind the scenes. Don’t ever move forward and sign up without first having a detailed conversation with them and really dig for the true facts. Ask the telling questions and if you don’t get straight answers, politely say thank you, and then walk away.
For any European based company you can also check the FCA website to determine if they are a DMA broker. Search for the company name, and check in the 'permission' section to see if they have the following accreditation "Limited Licence - matched principal broker". If they do then they are a true broker.
As for Darwinex, they have never operated a dealing desk. They use a DMA model enabling fulfilment on the open interbank market. Because the Darwinex business model is to get the best and most successful traders on their client list (in order to enable their unique investor proposition to be appealing – this is the point I started to make earlier - all will be explained later in the article). You can be guaranteed Darwinex is a broker that’s ‘on your side’ and will be a stepping stone to your success, not a thorn in your side, like so many other brokers.
Criteria #2 - Spreads and Commission
Note that some DMA brokers will pass through the market bid and ask prices but also add a small amount of spread on in order to levy part of their charging model. However, many brokers will simply pass through the best available bid and the best available ask. Because of this brokers who use this DMA model are not making much (if any) money from the spread, and therefore they charge a small commission per trade. When evaluating multiple brokers with differing charging models, it’s often difficult to do an apples-to-apples comparison to work out which would represent the cheapest option for you.
Because of these complexities of comparing brokers’ charges, I devised the concept of “Spread equivalence”. This takes the charges incurred from commission and converts them to what the spread with an equivalent cost would be. Adding this onto the average real spread then gives an overall single spread value that combines all charges (other than overnight swaps), allowing for a much easier comparison across different brokers regardless of whether they change commission or not, and regardless of whether they add a premium onto the spread or not.
Ascertaining the overall ‘spread equivalence’ costs can be time consuming and will require that you run code against the broker’s live platform over a period of time to give you statistically significant results for the average spread experienced.
I have done this for Darwinex over the last year for 22 currency pairs and will share some of those results with you in this article. But before we get onto spread equivalence, let’s take a look at the raw Darwinex spread.
Each of the charts below represent actual spreads on the production (live) Drawinex platform, sampled over a period of 3 hours. The spread is calculated once every minute, on the minute, producing 180 data points in total. As can be seen the spread regularly hits zero because of the best bid and best ask being presented to the terminal via DMA (Darwinex don’t add anything onto this). For example, the EURUSD spread was at zero, on 9 out of the 180 samples. Note this does not mean the spread only hit zero 9 times during the 3 hour period. It hit zero 9 times when it was measured, on the minute. It will have hit zero many more times between one sample, and the next one, a minute later. Scaling this up tells us that the EURUSD is at zero approximately 5% of the time. However, as can be seen, there are also many occasions when the spread is just 0.00001 or 0.00002.
Criteria #3 – Other charges
Criteria #4 - Broker Regulation
So is Darwinex regulated? Well you can probably guess that it is, because I wouldn’t use them if they weren’t. They are regulated by the UK FCA (Financial Conduct Authority), which is one of the most robust regulators (Although Darwinex is their trading name, their registered name with the FCA is 'Tradeslide Trading Tech Limited' and their FCA reference number is 586466) . Because of this regulation, it means that Darwinex are also covered by the Financial Services Compensation Scheme (FSCS) providing protection against firms going into insolvency. For investments, this provides 100% protection on up to UK£50,000. In addition to the financial safety net, regulation by the FCA also means that Darwinex is audited and has to follow best practice processes in order to retain its regulated status. Darwinex have offices in both London and Madrid. Their London location is in the heart of the Financial District here.
Criteria #5 – Supported Trading platforms
Darwinex supports MT4 but also have a FIX API. The FIX API option will enable two things: 1. For systematic / algorithmic traders it will allow trading with Darwinex from any trading platform that can call an open API, in order to execute trades, and 2. For manual traders, it will enable Darwinex to build their own proprietary trading interface.
Criteria #6 - Tradeable asset classes
As for Darwinex right now their platform offers a comprehensive list of currencies, in addition to the major stock indices (e.g. DJI, SPX500, FTSE etc) and major commodities (Gold, oil, etc)
Criteria #7 – Trading derivative options and leverage
Also consider the leverage options the broker provides. My advice here is don’t go crazy. Keep your leverage low, until you are really sure how your system tolerates drawdowns. If you over-leverage you will almost certainly break your account. It happens frequently to traders. Make sure you are not one of them.
Criteria #8 – Hedging
Darwinex supports hedging on its MT4 platform and so no issues.
Criteria #9 - Server Time Zone (and historical data time stamps)
At Darwinex, they use UTC (Coordinated Universal Time) on their servers currently, previously better known as GMT (Greenwich Mean Time), and this has been the case since they were founded.
Addendum: Darwinex has recently surveyed its traders to see if they would like them to convert to New York time in order to ensure 5 full candles per week, as opposed to 4 full candles and 2 partial candles. The final decision is still to be made.
Criteria #10 - VPS Provision (Virtual Private Server)
Darwinex doesn’t offer a VPS service themselves but have instead partnered with BeeksFX for this. The data centre where the VPS servers are based is located at London Equinix LD4 with good connectivity to the liquidity providers that Darwinex uses. There are 3 tiers of service available – Bronze, Silver and Gold. At the time of writing the review, the Bronze option is £18 per month, and offers a single VCPU and just over a Gig of RAM. From what I understand the quality of service is very good, although I don’t have any first-hand experience of it – In my opinion I think this is too expensive, and so I use an alternative service and one that works out to be more cost effective for me. Of course, there is no problem at all hosting a Darwinex MT4 client on a third party VPS, and this works fine.
Additional value-add criteria and benefits
You should choose your broker based on the main selection criteria at the top of this article. Not headline incentives. Remember, your choice of broker will help determine if you are successful as a trader long term. Don’t be swayed into going with a broker that will not help you achieve this just because you get a short term gain, which will often not be worth the paper it’s written on.
However, saying this, there will be factors that help to differentiate one broker from another. Again, I will use Darwinex as my example, not just because I use them as my broker, but because they also have a rather unique selling point, that will almost certainly be aligned to your longer term objectives as a trader. I split this up into 3 sections below for clarity, however they are all intrinsically linked:
- Trading system analysis & ranking – There are a few brokers and independent websites that allow you to grant read only permission to your trading account, and provide you with some really good statistics and insight into your trading system. These can be invaluable to help you understand your own system better and will save you a lot of work coding this analysis yourself. Myfxbook.com is one of the better known platforms. What they all lack however, is the ability to compare your system(s) with that of other traders in a 'fair way'. Until now. Darwinex has developed a suite of innovative algorithms that do exactly this – their DARWINIA system analysis platform. Each trading system is assessed using six criteria, what Darwinex call ‘Investable Attributes’. These combine to give each system an overall DARWINIA score. What’s more, in order to ensure traders are being compared like-for-like with other traders, a risk adjustment algorithm is used so that returns are normalised to standard risk levels. Darwinex use VaR or ‘Value at Risk’ as the basis for this adjustment. Because of this you really can compare your own trading skills and systems with that of other traders in a fair way. The six Investable Attributes are Experience, Risk Management, Consistency, Performance, Timing, and Scalability. I’m not going to go into any detail of these here, but if you want to learn more, Darwinex have made some excellent videos all available on YouTube. I have linked to a number of these for each IA above. What’s more if you already have a decent trading track record with another broker, you won’t need to start from scratch – Darwinex will allow you to migrate this track record into your New Darwinex account, so you’ll be able to see your score and ranking straight away.
In terms of the rationale behind each of the 6 IAs I think that they are pretty good. I have certainly gained some really good actionable insight into my trading systems. I do however have a major issue with the 'Consistency' IA. I believe this penalises good investors that use system diversification within their trading accounts. You see, it looks for a consistent pattern of trade duration versus profit/loss. For accounts that diversify across different systems, and time frames however, this by its very nature leads to a wide variance and therefore scores badly. I have raised this with Darwinex on a number of occasions, but the good news is that they now agree, and are making changes to the underlying algorithm.
Addendum - Now resolved :)
- Darwinia Monthly Contest – I addition to the metrics that will be at your fingertips if you have a Darwinex account, you will also be able to take part in the monthly Darwinia Contest. This uses a combination of criteria including the Darwinia Score, and also the return the the trader has achieved that month to rank traders and allocate prize money. At the time of writing they are paying out 6000 Euros per month to the top 14 traders systems. Take a look at the current month’s rankings.
Addendum: Darwinex no longer pay 'cash' prizes but instead invest capital into the best traders systems. As of May 2016 they are investing a total of €600,000 (over half a million Euros) every month into the top 23 traders - WOW!.
- Investor Capital – I’ve left this until last but in actual fact it is the most important. The whole concept of Darwinex is not to merely act as a broker for traders. What they have done is built a really innovative platform that, as Darwinex puts it “pairs up skilled traders with investor capital”. This probably deserves some explanation. Investors are always looking for opportunities to get a good, and reliable return on their capital investments. Equally there are a lot of talented traders out there who are not maximising their potential because although they have the brains, skill, and ambition, they simply don’t have the capital to benefit properly from it. That’s where Darwinex’s unique proposition comes into play. They allow investors to select systems from the most talented traders (based on the Investable Attributes I mentioned earlier) to invest in. The platform makes it extremely simple for them to do this. Investing in a traders system is as easy as buying a stock. The investors 'buys into' the trader's system at its current quote price, by simply clicking the 'Trade' button as shown below.
Then over time, all of the trader’s individual trade decisions combine to change the quote price. If the trader is doing well their quote price goes up, and vice versa if they are not doing well. There is a lot that goes on behind the scenes, for example to carefully manage risk on behalf of the investor, but in a nutshell Darwinex act as an investment broker between trader and investor. The trader is then compensated for any profit they make for the investor. Note that this is a different (and much better) proposition to the copy trading platforms such as eToro on a number of fronts. Again the details of that are beyond the scope of this article, but again there is a good video here that explains.
I mentioned before that I’ve now been with Darwinex for about a year, and I can safely say that I have complete confidence in them, and I know that they will support me and Trade like a Machine to achieve our goals. They are without doubt the best broker I have ever used. I mentioned in the article you should never open an account without first having a proper dialogue with the broker on the phone, webchat or email. Get to the nitty gritty of what you really need to answers to. The Darwinex customer support team are some of the most helpful people I’ve come across. They really can’t do enough to assist you. I would advise that you at least incorporate Darwinex in your short-list for further evaluation, as you work towards selecting your next broker. If you do decide to move forward, you can sign up here.