A forex broker is necessary unless you wish to make money by exchanging currencies with strangers on the street.
Of course, a foreign exchange (Forex) broker is available to meet the needs of any trader around the globe, including the millions who also use this market. Many newcomers to the forex market wonder, “How do forex brokers generate money?”
All Forex traders must deal with Forex brokers, whether they like them or not. The majority begin their trading journey by trying to find the best forex brokers fast.
To avoid being taken advantage of by unscrupulous brokers that engage in techniques like “stop-hunting,” it is crucial to understand their business model, revenue streams, and risk mitigation strategies.
In the following paragraphs, we’ll look closely at Forex brokers and how they generate revenue.
The difference between the asking and the bidding price of a currency pair is known as the spread. A currency pair’s ask rate is what you’ll receive if you buy (or “go long”) on it. You will also receive the bid price to end a long position or “go short” on a currency pair. Your broker makes money off the spread between the bids and asks prices.
Spreads are typically flexible and are determined by the state of the market. Spreads can widen dramatically and increase your trading costs if there is significant and unexpected news in the market. Most brokers have very modest spaces during normal market conditions, often about one pip for most significant pairs.
Typically, the best spreads of the day for day traders can be found during the overlap of the New York and London trading sessions.
Liquidity (Loan) Financing
Sweeps are a significant source of annual earnings for some forex brokers, including financial technology behemoth TD Ameritrade.
Sweeps include investing clients’ idle cash with a forex broker‘s banking partners or subsidiaries, which can fulfill additional loan requests with interest. When the money is invested wisely, interest is earned on it. Some good is passed on to the customer through higher-than-average interest on savings or checking accounts.
However, these profits are still dwarfed by the power of the forex broker’s (now twice-reinvested) funds, which accrue interest.
Commissions Charged by Brokers
When trading foreign currency, some brokers may charge a flat fee for each transaction, while others will take a cut of the spread between the bid and ask prices. Profit for forex brokers comes mainly from two sources: the space and fixed fees for each round of trading.
Although some brokers still charge for both, that practice is becoming increasingly rare due to market forces pushing for lower prices across the board. Unfortunately, some less than honest Forex brokers have promoted commission-free trades in the past, but what they usually do to make up the difference is charge extra in the spread.
The spread may be set, or it may fluctuate. The spread in a liquidity pool with a variable spread changes in response to the volume of orders. The spread often widens when a significant announcement, such as the U.S. Nonfarm Payroll Numbers.
As a result, you can spend more than you bargained for in spread in a very volatile market. Knowing exactly how much you’ll be charged to facilitate purchases and sales is the primary benefit of a fixed spread.
Platforms for Making Investments
Regarding revenue, trading platforms are the next most important source for Forex brokers. Most brokers provide free access to proprietary and third-party trading platforms. However, some may charge for more advanced tools.
As a professional trader, you may want to investigate the Forex trading platforms your broker provides to see if any of them have special tools that would be useful in your everyday dealings. One crucial consideration is whether or not the value added by the service outweighs its price in terms of increased profits or efficiencies.
In contrast, novice traders probably don’t need more than what’s available on most free trading platforms.
Associate Application Programming Interface
Some forex brokers have devised the ingenious idea of licensing their proprietary software, the code that powers the platforms that process your forex trade orders.
It is typical for licensing APIs to provide licensees with the ability to tailor the program to the specific needs of their user base. Some may even offer co-marketing opportunities (where the licensee is highlighted on the licensor’s website).
More Helpful Services
And last, certain brokers may provide optional extra services for a fee. A more comprehensive selection of tradable instruments, expert market research, trading signals, and data on market depth may all be available to you for a small fee.
Look for a no-dealing desk broker who forwards their clients’ orders to third-party liquidity providers if the prospect of a conflict of interest with your broker concerns you. You must research options and select a broker best suits your trading style and preferences.