How Do Forex Trading Brokers Get Paid?
One of the perceived advantages of having Forex trading brokers is that you don’t have to pay them a commission. But don’t make the mistake of thinking your fee free, friendly broker is just there helping you out of the kindness of their heart. They need to make their money too. So exactly how do Forex trading brokers get paid?
Basically Forex brokers make their money whenever a trade takes place. They are actually compensated in several different ways:
- Interest earned on deposited funds
- From the buying and selling of currencies
- Rollover fees
- Holding and converting different currencies
But the majority of the broker’s money is earned in the buying and selling of currencies. The way in which they make their money is from the difference between the asking and bidding price of the respective currency pair, this is called the spread. When a Forex trader pays for a position it is at the ask price. The bid price is referencing the amount at which the position could be sold.
If you are at all familiar with Forex terminology you will have seen reference to a pip. This is Forex’s smallest unit of measurement and is equivalent to .0001, with the exception of the Yen which is .01. Generally the spread is around 3 or 4 pips, and this is what the broker gets from the buying and selling of currencies.
The broker can be compared to a middleman, and doesn’t make any direct charges to anyone. What the broker does, is buy a position from another large financial institution, then resells it to his client, the Forex trader, the difference between the buy and sell goes to the broker. The forex broker can add a bit to the bid and ask prices, and basically make some profits on the spread. (The difference between and the bid and ask is referred to as the spread). So even if you are not charged a commission, the broker can make his or her profits.
For example the broker could set the ask price at 1.350 and the bid price at 1.346. Then if the Forex trader sold straight away, the most they could get would be the bid price of 1.346, which results in a loss of 4 pips to the trader. However, since most Forex transactions are in $100,000 lots, the broker will have made $40 in that particular exchange.
Spreads vary dependent on the currency being traded and the broker. But a normal spread is around 3 to 5 pips. Forex trading brokers play an important role in the trading market, due to the immense size and amount of transactions. Trillions of dollars pass through the Forex markets every day, and most of these are in $100,000 lots, though you can find smaller $10,000 mini-lots. Forex transactions tend to be highly leveraged, with traders usually putting up one hundredth of the capital.
Quite often you will find that Forex trading brokers are either associated or partners with financial institutions or investment banks. These larger institutions act as the backers to guarantee the loans for the Forex trading. If this wasn’t the case many people would be restricted from being able to trade unless they had the requested 100% as opposed to 1% to deposit.
It is not disputed that Forex trading brokers make money from investors trading on Forex, but they provide a real and useful service. Tread carefully if your broker advocates day trading or something similar, unless you have a lot of experience – this is the fastest way to lose your money in the most liquid market worldwide.
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