How Forex Brokers Make Money



 

In the foreign exchange market, traders and investors buy and sell different currencies based on  whether or not they believe the currency will grow or drop value. Forex or foreign exchange market involves great risk and sees over $5 trillion dollars traded everyday. Traders have to go through an intermediary, for instance, a forex broker to implement trades.

Regardless of the gains or losses sustained by traders,  foreign exchange brokers make money on commissions and fees—some of them are hidden charges. Understanding how foreign exchange brokers  make money can surely help you in selecting the right broker.

Role of the Foreign Exchange Broker

The role of a foreign exchange broker is to take orders to buy and sell currencies and executes them. This broker usually works on the over the counter or OTC market. The foreign exchange market is not subject to similar regulations as other financial exchanges. Forex brokers might not be subject to many of the procedures that govern securities transactions.

In this market, there is also no centralized clearing mechanism, which means that you have to be watchful that your counterparty does not fail to pay. You  need to make sure to check your counterparty and his capitalization before you continue.

Forex Broker Fees

In return for completing buy or sell orders, the forex broker will charge a commission per trade or a spread. This is how foreign exchange brokers earn their money. A spread is the difference between the bid price and the ask price for the trade.The bid price is the amount you will get for selling a currency, while the ask price is the amount you will have to pay for buying a currency.

It is the broker’s spread that makes the difference between the bid and ask price. A broker could also charge both a commission and a spread on a trade. On the other hand, other brokers may offer commission-free trades. Actually, these brokers may earn a commission by widening the spread on trades.The spread can be either fixed or variable.  If the spread is variable, the spread  will be different depending on how the market changes. In a major market event such as changes in interest rates, it can cause the spread to adjust. It can be satisfactory or unsatisfactory for the trader. If the market gets unpredictable, the trader can end up paying much more than he/she anticipated. Another thing to remember is that a foreign exchange broker can have different spread for buying a currency and for selling the same currency. Therefore, the trader has to pay attention on the pricing.

Generally, the brokers who work with a number of large foreign exchange dealers to get competitive quotes are well capitalized and usually offer competitive pricing.

The Bottom Line

Those who are thinking of trading in the foreign exchange market will have to very careful. Many foreign exchange traders have lost money as a result of deceitful schemes that promise great earnings in this thinly regulated market. In the foreign exchange market, prices are not transparent and each broker has his own quoting techniques. It is up to the traders who are transacting in this market to study broker pricing to make sure that they are getting a good deal.

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