Last Updated on January 14, 2020
The brokerage industry experienced tremendous growth as the Internet penetration in our everyday lives increased at the start of the 21st century. Online trading made it possible for retail traders with small accounts to participate in the largest financial market in the world – the foreign exchange market.
Before the Internet era, speculation on the currency market was so expensive that it prohibited most of the retail traders to participate. High commissions and latency in getting trades executed meant few retail traders afforded to invest in currencies.
Things changed, and costs decreased in time. It is now so easy to open a trading account, and open positions in the foreign exchange market that all one needs is a stable Internet connection and money to fund the account.
Using leverage, Forex brokers enabled even the trader with the smallest trading account size to participate in the currency market – a tremendous leap forward that changed the trading industry forever.
The Role of the Forex Broker
The Forex broker plays different roles. It is not only an intermediator, the link between the market and the trader, but also a trader’s partner and, sometimes, advisor.
As an intermediator, it connects the trader with the market. It takes its best possible price quotations from liquidity providers and offers the quotes to traders. These, in turn, place bets that one currency will appreciate or depreciate against another. For this service, the Forex broker charges a fee.
As a trader’s partner, the Forex broker has a more complex role. By offering various types of accounts available to the trader, it shows flexibility and the willingness to adjust to any trading strategy. Also, as a partner, the Forex broker’s role is to warn its clients about potential events that may require special attention – events that cause spreads to widen and require more margin in traders’ accounts. Such events are elections, referendums, and so on.
On top of the two roles mentioned, a Forex broker is also an educator. Its job is to attract as many new customers as possible, but also to retain them as active traders. A broker earns from the fees charged to a successful trader – if the trader is not successful, he/she won’t trade anymore, and the broker sees its income decreasing.
As an educator, the Forex broker makes sure to explain how the market functions, what are the best ways to approach it, what are each currency pair’s particularities, trading theories, and strategies to use – but doesn’t offer trading advice. The job is to educate, and each trader uses the resources on his or her own risk.
A Forex Broker Business Model Explained
There are multiple ways a Forex broker may organize its business. Some of them act as market makers or dealing desks, some other ones as no-dealing desks, and some others run a hybrid business model, combining the advantages and disadvantages of the two.
Market makers literally create their own market. It means that the prices on the trading platform, while similar or close to similar to the actual market, only mirror the market. Advanced technology allows for a very fast illustration of all market activity, but the trading takes place against the broker.
Market makers, in other words, trade against their clients, and the more the clients lose, the more the market maker stands to win. Statistics help because over 80% of newbie retail traders lose their first deposit in the first six months due to lack of experience or simply falling prey to aggressive advertising. Knowing this statistic, market makers take the other side of their clients’ trade and stand 80% chances to win – not bad for any business dealing with odds and probabilities.
No-dealing desks route their clients’ trades to liquidity providers and pick the best quote for every single trade. The more liquidity providers, the better trading conditions the broker has to offer. No-dealing desks offer trading accounts based on Electronic Communication Network (ECN) and Straight-Through Processing (STP) technologies, meaning they execute the clients’ orders anytime there’s a market – in foreign exchange, there’s always a market.
Hybrid brokers ran variations between the dealing-desk and no-dealing desk systems. Some keep only part of their customers orders in-house and route the rest to liquidity providers, for instance, running a business model as a combination between the two.
Explaining How Forex Brokers Make Money
Depending on the business model adopted, a Forex broker has different sources of income. In general, a Forex broker earns a fee from spreads (difference between the bid and ask quotations of a currency pair), from a commission (directly correlated with the trading volume), from trading against its own customers (market makers) or from other adjacent costs transferred to the trader (e.g., convertibility costs when funding the account or when withdrawing).
Any Forex broker has a strong interest in having active customers. Market makers invest a big chunk of their profits in aggressive advertising campaigns to attract new customers to sustain the business. Because there’s still a huge potential for Internet penetration to expand, market makers fight for new customers and don’t bother much to retain successful traders.
On the other hand, no-dealing desk brokers have every interest for the traders to be profitable. Such brokers earn a commission and/or a fee on each transaction that the trader makes: the more transactions, the more income for the broker. Hence, the two (i.e., the broker and the trader) have their interests aligned, and they can build a successful partnership.
Forex Brokers Fees – An Important Part of the Forex Broker’s Income
Fees, or what the broker charges for its services, are the main source of income for a no-dealing desk broker. Such a broker runs its business with fairness in mind and simply asks for a fee in exchange for the services provided (i.e., access to the foreign exchange market, leverage, improved trading conditions, negative balance protection, segregated funds, and so on). It acts like any other business from any other sector – charges a price (fee) for its products and services.
The spreads between the bid and ask price are a big part of a Forex broker’s income. They differ from product to product (e.g., spreads on the currency pairs are tighter than ones on contracts for difference – CFDs – or commodities) and even within the same product class (e.g., different currency pairs have different spreads).
A particularity of this type of Forex broker fee is that it is charged at the closing of a position. Thus, brokers prefer traders that quickly open and close positions, involved mostly in scalping trading strategies rather than in swing trading or investing.
Commissions also apply to each trade but are deducted directly from the equity of a trading account the moment the trader opens a position. Their size depends on the type of trading account, and the volume traded – the higher the volume, the bigger the commission paid.
As a no-dealing desk broker, FXOpen invests in every trader’s success. Because a trader’s profitable trading strategy means a higher income for FXOpen too, traders feel comfortable knowing that FXOpen is a true partner ready to help in their trading journey. Find out more about the FXOpen trading conditions by visiting our website.
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