5 Ways Forex Brokers Make Money
The foreign exchange, or forex, market is the largest and most liquid financial market of the world. Its average trading volume is estimated to be around 4 trillion USD a day where traders can buy and sell currency 24 hours a day. Traders who start a career in this market often find the same amount of opportunities and risks that could either make or break their career.
The forex market is one of the top investments for young Australians. If you’re planning to start a forex trading career, then you have to learn everything you can about the industry and select a reliable broker to assist you in your journey.
What is a forex broker?
One of the most important factors in starting a forex trading career is to hire a trustworthy forex broker. When hiring a forex broker, it’s important to consider their account offerings and compare them with other brokerage firms. This requires considerable research, which often involves visiting company websites, reading information from reliable sources, and taking into account the different experiences each client had when working with the said firms.
While it may take some time, learning to choose which firm you can work closely with is definitely an investment worth every second. Here are two kinds of brokers:
- Regulated brokers are firms that provide currency traders with access to trading platforms that allow them to buy and sell various foreign currencies.
- Nonregulated brokers are firms that also operate in the same manner although they are not bound by the same standards that regulated brokers must adhere to.
In selecting a broker, hiring the latter may pose more risk because they could potentially take advantage of their unrestricted freedom.
How do forex brokers make money?
After hiring a forex broker, you may need to open up a trading account and put in a deposit. This allows you to start your trading career that involves buying and selling currency. During these sessions, you may require your broker to carry out a few orders which can come at a price. While this is one way forex brokers make money, there are also other forms of how they make a profit.
Depending on the legitimacy of your partner, your forex broker may make profit from the following:
1. Currency pair spreads
Before talking about spreads, you need to understand what a pip is. A pip, or price interest point, spread refers to the difference in pips between the bid price and the ask price quote in a single currency pair. This is considered the largest income source for brokers to receive compensation for each transaction. During this process, brokers are given lower spreads access where they add markups to said spreads before forwarding traders the quotes. This allows a company to earn the lost money by the traders on a spread.
Trading on leverage is a great way to potentially increase your profit while not necessary depositing a large sum. Brokers earn income by offering high leverage positions that you can use during trade. This, of course, allows them to enjoy a portion of your earning should your trade be considered a success. However, it is important to note that while you can increase your chances of profit, the possibility of losing more than you expect also increases.
3. Swap spreads overnight
Overnight swap spreads refer to the value of the interest rates in a currency pair depending on its trading success. The brokers are the ones to pay the overnight swap difference to the trader if the currency pair is moving positively in the trader’s position. However, if the pair moves negatively from the trader’s position, then brokers get paid from this movement. While brokers can make money this way, these payments aren’t necessarily symmetrical and can be biased to favor the forex broker in question.
4. Commission for payment processing
Most online forex brokers don’t charge a commission for every trade, save from a few accounts such as Islamic accounts, and make it a marketing point to gain more clients. However, there are some brokers that require payment processing fees, which are only deducted from you when you make a withdrawal or deposit in your account.
Fortunately, these deductions are relatively small and are fixed in units of currency instead of percentage points, so you’ll know the exact amount of what they charge each time. This kind of earning incentivizes them to help you become successful in your trade so that you will stay with them longer.
5. Going against the client
Unfortunately, not every broker has your best interest at heart. In a market as competitive as the forex market, many people often use this as an opportunity to increase their profit without necessarily respecting proper rules. One such example is when forex brokers start trading against you. Brokers who do this generally don’t want you to succeed although their methods aren’t always obvious.
To be on the safe side, here are some signs you need to watch out for:
- Spreads that are considered too low
- When the price is significantly different from other brokers
- When your broker is unresponsive or evasive
- When your broker is insistent on interrupting your trade
The last one is especially harmful because forex brokers more or less only work to carry out orders. They aren’t as invested in your success or your failure because they have their own means of making money. So, if you suspect that your broker is getting too close to comfort, it may be a sign that they’re betting for you to lose and don’t want you to succeed.
There are various ways that forex brokers can make money. Most of which are generally reflected in their terms and conditions once you decide to work with them. While the last of the list is generally unethical, it is still worth mentioning because it could help you to become more careful in picking your brokers wisely. Indeed, there are many risks involved in trading forex. The best thing you can do to ensure your success is to work with a broker you can trust.
Great article, Suprabhat! It’s also important for new traders, as well as seasoned professional, to never risk too much on one single trade. A max risk of 1-2% of equity should be enough to keep your account from blowing up, and is sufficient to make big bucks from a stellar trading strategy.