Trading in today’s foreign exchange landscape is a great place for beginners looking to dip their toes into trading and investing in the financial markets.
Nonetheless, picking the right broker who is best suited to your needs and doesn’t charge exorbitant service fees for your investments and transactions is step number one before fully submerging yourself into the foreign exchange market. Thus, we’ll take a deep dive into the different kinds available and break down how forex brokers make money.
1. Spreads
The most common way brokers can make their money is via spread, which is the difference between the bidding and asking price and the cut that the broker takes on your position.
If the quote indicates a spread of 1 pip, your fx broker would display your desired trading currencies at 1.1000/1.0001.
How to avoid high spreads – double check the spreads of the forex broker prior to depositing. You can also check spreads for your forex pairs in their demo platform first.
2, Commissions
Forex brokers can also make money via commissions, which are charged when traders open and close orders.
ECN forex brokers most frequently charge commissions to ensure they can continue to profit from trading accounts that have spreads close to zero. In fact, the fierce competition among forex brokers nowadays has resulted in relatively cheap commissions.
3, Other Fees
Deposit & Withdrawal Fees
Users could pay a fee based on how they decide to fund their forex trading accounts. These costs frequently originate from the bank or payment processor and do not generate revenue for the brokers themselves.
- Bank Wire Fees – If you deal with a regulated forex broker, then this is usually the safest and cheapest option for medium and larger money transfers. However be smart and check with your bank prior to initiating a money transfer abroad. Some interbank fees can be sky high, for example transfer between Australia and Europe can cost $50.
- Card processing Fees – Card companies like Visa and Mastercard usually charge small transaction fee to a merchant. It is a preferrable way to transfer your small funds (couple hundred dollars) to a forex broker that is usually capped at around $10k max by a card processing company.
- Paypal, Skrill, Neteller – Favorite way to move funds for traders from Africa or Asia where banks are expensive, non-existent or they tend to ask strange questions or straight away block money transfers to forex brokers. Be sure to check the fees which can be around 1% – 4% from the volume you are about to send.
Inactivity Fees
Your broker will probably impose an inactivity fee if you keep your trading account funded but don’t trade for a predetermined period of time. If there hasn’t been any trading activity for more than a year, your account will often be assessed an inactivity fee monthly or quarterly.
4, How Different Types of FX Brokers Make Money
ECN Brokers
ECN brokers provide a real-time connection between you and other foreign exchange market participants. These participants include everyone from traders like yourself banks, hedge funds, and other financial institutions.
Without the influence of an intermediary, ECN forex accounts and agents give traders immediate access to the best bid and ask rates. This means these bids and ask rates being given by the interbank market players during periods of high trading volume may be the same and therefore exhibit a spread of zero. ECN accounts are usually the bread and butter of high-volume traders who could also happen to run automated systems that require tight spreads.
However, spreads are still contingent on the fluctuations of the forex market; the spread will not always be zero, especially if there is no price available due to a string of low-activity market hours or volatility. Rest assured, ECN brokers don’t have vested interests; they’ll make money whenever you decide to trade, no matter how large or small the spread may be. Their money comes in with the commissions they earn on every trade; the more you make, and the more you trade, the more money brokers will make.
STP Brokers
Conversely, while this next kind also operates on a business model without a dealing desk, STP forex brokers redirect user orders through to a liquidity provider – an organization that acts as the middleman in the trade. These providers connect currency sellers and buyers to provide the necessary liquidity to the foreign exchange market, and they’ll provide lower spreads than typical brokers.
As a result, while you’re getting some exclusive prices, spread markups are added to compensate the STP forex broker of choice. Trading with an STP forex broker pits you against other market players rather than the retail forex broker.
Similar to the ECN approach, it eliminates any potential for conflict of interest, making this significant in the long run. Instead of accepting your losses, the broker actually wants you to win, so they may profit from the spread markup they apply to every deal.
Market Makers
Market makers are vastly different forex brokers in the sense that they execute orders through a dealing desk. Aiming to reduce the risk of these transactions, they create a market for their customers by setting bidding and asking prices for liquidity and matching purchase orders with selling orders already on their books. On the other hand, they can also take the opposing side of the transaction and act as the counterparty to their client’s holdings.
Market-making forex brokers profit on spreads and bets placed against their clients’ positions, which is why some people find it hard to trust these kinds of intermediaries. Nonetheless, one significant advantage of opting for a market maker is that they are the only forex broker able to provide traders with set spreads.
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