This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
Choosing a regulated stock broker is one of the most important decisions a trader makes, and the regulation is the foundation of the trading relationship. The regulated broker follows the rules, segregates the client funds, and provides the protections the trader needs. The unregulated broker does not have to follow the rules, and the unregulated broker does not have to segregate the client funds. The trader who picks a regulated broker can trade with confidence, and the trader who picks an unregulated broker takes on unnecessary risk.
Why regulation matters
The first reason is the protection of the funds. The regulator requires the broker to keep the client funds in a segregated account at a tier-1 bank, and the segregation ensures the trader's funds are not used for the broker's own operations. If the broker goes bankrupt, the segregated funds are returned to the trader, and the bankruptcy of the broker does not affect the trader's funds.
The second reason is the protection from fraud. The regulator requires the broker to follow the anti-money-laundering rules, and the regulator requires the broker to verify the identity of the clients. The verification reduces the risk of fraud, and the verification reduces the risk of the broker being used for illegal activities.
The third reason is the protection from unfair practices. The regulator sets the rules on the leverage, the disclosure, the reporting, and the execution, and the regulator enforces the rules through inspections and fines. The trader who uses a regulated broker can rely on the rules, and the trader who uses an unregulated broker has no recourse in case of dispute.
The main regulators
In the European Union, the main regulators are the Financial Conduct Authority (FCA) in the United Kingdom, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in Germany, the Autorité des Marchés Financiers (AMF) in France, the Autoriteit Financiële Markten (AFM) in the Netherlands, and the Cyprus Securities and Exchange Commission (CySEC) in Cyprus. The regulators have different rules, and the regulators have different levels of enforcement.
In the United States, the main regulators are the Securities and Exchange Commission (SEC) for stocks and the Commodity Futures Trading Commission (CFTC) for futures. The SEC and the CFTC have strict rules, and the regulators have a long history of enforcement.
In Asia, the main regulators are the Australian Securities and Investments Commission (ASIC) in Australia, the Securities and Futures Commission (SFC) in Hong Kong, and the Financial Services Agency (FSA) in Japan. The regulators have different rules, and the regulators have different levels of enforcement. The offshore regulators have less strict rules, and the offshore regulators have less enforcement power.
The investor compensation schemes
The investor compensation scheme covers losses up to a certain amount if the broker goes bankrupt, and the coverage varies by jurisdiction. In the European Union, the coverage is up to €20,000 per client under the FCA, the BaFin, and the AMF. In the United States, the coverage is up to $500,000 per client under the Securities Investor Protection Corporation (SIPC). In Asia, the coverage varies by country, and the coverage can be up to HK$500,000 per client under the SFC.
The offshore jurisdictions may not have an investor compensation scheme, and the offshore jurisdiction may not cover the losses. The trader who uses an offshore broker is not covered by the home regulator's scheme, and the trader has limited recourse in case of dispute.
How to verify the regulation
The first step is to check the broker's website. The broker publishes the licence number, the regulator's name, and the regulator's website. The trader should verify the licence, and the trader should check the regulator's website for the list of authorised brokers.
The second step is to check the regulator's website. The regulator publishes the list of authorised brokers, and the regulator publishes the enforcement actions. The trader should look for the broker's name, and the trader should check the enforcement record.
The third step is to read the broker's risk disclosure. The broker should publish the risk disclosure, and the disclosure should explain the risks of trading. The trader should read the disclosure carefully, and the trader should look for hidden risks or unfair terms.
Red flags to watch for
The first red flag is an unlicensed broker. The broker does not have a licence from a recognised regulator, and the broker does not have a regulator's website. The trader should not open an account with an unlicensed broker, and the trader should look for another broker.
The second red flag is a bonus with a withdrawal lock. The broker offers a bonus, and the bonus is locked until the trader reaches a high trading volume. The bonus structure can be designed to make it hard to withdraw the funds, and the trader should read the terms before accepting the bonus.
The third red flag is poor customer support. The broker takes days to respond to a question, and the broker does not answer the phone. The customer support is a sign of the broker's professionalism, and the trader should test the support before depositing the funds.
The fourth red flag is inconsistent information. The broker's website says one thing, and the broker's customer support says another. The inconsistent information is a sign of the broker's lack of professionalism, and the trader should look for another broker.
Common questions about regulation
What is the best regulator for a retail trader? The best regulator for a retail trader is a tier-1 regulator like the FCA, the BaFin, the AMF, the SEC, or the ASIC. The tier-1 regulator has a long history of enforcement, and the tier-1 regulator has a strong investor protection framework.
Does the regulation cover all products? It depends on the regulator and the product. The FCA regulates the brokers, the products, and the markets, and the FCA's rules cover most products. The SEC regulates the stocks, the bonds, and the funds, and the SEC's rules cover most products.
Can I trade with an unregulated broker? The trader can, but the trader should not. The unregulated broker does not have to follow the rules, and the unregulated broker does not have to segregate the client funds. The trader who uses an unregulated broker takes on unnecessary risk, and the trader may lose the entire deposit.
Related resources
Where to start
If you are choosing a regulated stock broker, the most useful first step is to shortlist three to five brokers regulated in tier-1 jurisdictions, and to verify the licence and the regulator for each broker. Our broker comparison lists the brokers by jurisdiction, which together tell you what the broker offers before you open the account.