We all know how forex traders make money. But have you ever wondered how forex brokers make money?
As a trader, understanding how forex brokers make money can help you make an informed decision when choosing one. The main role of forex brokers is to take orders from traders to either buy or sell currencies and executes them. Unlike traders who can make or lose money through forex trading, forex brokers have put various measures in place that ensure that they make money regardless of the gain or loses sustained by the trader. In this article, we are going to present six ways of how forex brokers make their money.
Cost of Trading, how forex brokers make money
This is the primary source of how forex brokers make money. Spread is actually the difference between the bid and the ask price of a specific trade. The bid price is the traders selling price for currency while the ask price is the actual price received after purchasing a currency. The difference between the bid and the ask price is the commission that the broker earns. Spreads are available in two forms. They include fixed and variable spreads. For the case of variable spreads, the entire spread will vary depending on market movement. For the case of fixed spread, the entire spread remains fixed regardless of market volatility. Typically, forex brokers usually access lower spreads. However, they usually add a mark up to the spread before giving the trader a quote. This move usually ensures that the broker makes money regardless of the gains or losses made by the trader.
Offering High leverage to traders
Spreads that forex brokers earn on small portions are negligible and cannot sustain them. To counter this, forex brokers usually offer high leverage to traders. High leverage increases both profits and losses of the trader. Most brokers usually give traders a better deal just to encourage them to trade more money. High leverage also benefits the broker especially in the event that the trader makes loses.
Trading or hedging against clients
This may come as a surprise, but that is how forex brokers make money. Some brokers trade against their own clients. Although this is unethical, it is one of the tactics that brokers use to make money and it is very profitable. If you notice that the broker is thriving when you lose, or if the spreads are too low then that is a red flag that indicates that the broker is trading against you.
Commissions charged on payment processing
Some forex brokers charge a fee for payment processing. The fee is usually small and is deducted when the trader withdraws or deposit money on their account. Of course, the commission fee is too small to make any big impact on the broker’s profits but it is good enough to cover up the broker’s expenses. However, most online brokers don’t charge payment processing commission.
Overnight charges or swap fees
Overnight swap spreads mean that the broker gets to pay the trader if the difference between interests in a particular currency pair is positive. On the other hand, if the difference between interest in a particular currency pair is negative, then the opposite happens meaning that the trader gets to pay the broker. In most cases, the overnight swap spread usually favors the broker. For instance, if a particular trader is buying EUR/USD and another trader is selling, the same amount of that particular currency pair, the first trader will earn money on overnight swaps while the second trader will lose that amount. That alone is big enough to enable the broker to compensate the first trader and still remain with a good amount.
Another brilliant technique that forex traders use to make profits is by trading by themselves. This is usually referred to as proprietary trading. One advantage that forex brokers have is access to information. They know traders who are very successful in forex trading and those who are not. If they notice that a trader is very successful, they can decide to follow the trading strategy of that particular trader but trade a higher amount. For instance, if a trader decides to trade one lot to earn a profit of $100, the broker can place 3 lots on the exact position, make $100 for the trader and earn a profit of $200 for themselves.