In the Forex market, speculators and traders buy/ sell various currency pairs based on whether the currency pair will appreciate or depreciate. The forex market is known to be a high-risk market; it has over $5 trillion daily trades. Traders and investors need an intermediary to execute trades. This intermediary is a Forex broker. Regardless of the losses or gains sustained by a trader or investor, a Forex broker makes money on fees and commission. Understanding how they make money will help you choose the best broker.
How Do Forex Brokers Work?
Have you ever thought that how Forex brokers work? To answer this question, you should know the different kinds of Fx brokers and their various business models. Not every business model is created equal. So, let’s discuss the different types of Fx brokers and how they work.
Market Makers
Nearly every Forex broker will say that they make money from spreads. But many get a small fraction of their revenue from spreads. So, how do they make money? By trading in the Fx market against their clients. They are known as the market makers. Most Fx brokers work in this way. They earn money if their clients lose and have an interest in their clients losing money. The market makers recruit many new traders and offer some bonuses or free and substandard education. Due to their inherent conflict of interest to make the market, some market makers engage in nefarious tactics.
Straight-Through Processing (STP) Brokers
STP brokers work on the business model you imagined a market maker broker used. They earn money through spreads, and you trade against the other market participants. An STP broker aggregates the price from the liquidity provider and adds a small markup. Next, you put an order with the Forex broker, and he passes it on to a liquidity provider. Since you trade against other participants and not the broker, the STP brokers don’t have their interest in your losses.
ECN Brokers
An ECN broker is favored by most high-volume and professional traders. When it comes to order execution, this business model is nearly the same as STP. You trade against other participants and not the broker. The main difference between an STP broker and an ECN broker is that the ECN brokers do not make money from spreads. However, they charge a flat commission on every trade. No mark-up and razor-sharp spreads along with transparent fees make an ECN account a favored option for professional traders, scalpers, and investors having automatic systems.
There is no conflict of interest with this model between the traders and the brokers while trading on the ECN account. An ECN broker wishes you to succeed in Forex trading, start to trade size, and grow the account. The larger size you trade in the Fx market, the better your broker will make. In this business model, both the client and broker’s interests are in ideal alignment.
Why Do You Need a Forex Broker?
A Forex broker is a body that connects the forex traders and investors with the Fx market. To access the Forex market 24/7, traders use these brokers. The Fx market trades on interbank systems means that banks trade with each other electronically at different rates that might vary from one bank to another. A forex broker offers you an excellent way to get in the mix with banking networks and buy currency pairs to hold.
A Forex broker takes the order to sell or buy currency pairs and executes them. They generally work on an over-the-counter market. This market is not subjected to the regulations like other exchanges. And hence the Fx brokers are not subjected to many rules that govern social transactions.
There is no centralized mechanism in the Forex market. So, be careful that the broker does not fault. Ensure that you inspect the reliable forex brokers and their capitalization before proceeding.
How Do Forex Brokers Earn Money?
To execute a buy or sell order, an Fx broker will charge spreads or commissions on every trade. That is how the forex brokers earn money. A spread in the Fx market is the difference between a bid and an asking price. The bid price refers to the rate you will get to sell a currency. The asking price refers to the rate you will need to pay to buy a currency. Some Australian forex brokers charge both spreads and commissions on the trades. Some of them claim to provide commission-free trades. Such brokers make their commission by expanding the spreads on their trades.
A spread in the Forex market can either be fixed or variable. With variable spreads, the spreads may differ based on the market movements. A big market event like changes in the interest rate can make the spread change. It can be favorable or unfavorable. If the Forex market becomes volatile, you may end up paying a lot more than what you expected. A Forex broker may also have various spreads for both buying and selling a currency. So, pay attention to a broker’s pricing.
The Forex brokers who work with many big foreign exchange dealers and are well-capitalized to get highly competitive quotes generally offer highly-competitive prices.
Some Fx brokers also charge extras for education and customer services. For instance, some will provide thorough analysis, and a few will offer webinars and educational classes. If you know to trade and do money management, you will hardly need these.
Conclusion
People who contemplate trading in the Fx market will need to proceed cautiously. Various Forex traders have lost their money due to fraud get-rich plans that promise excellent results in this market. The Fx market isn’t one where the rates are transparent, and every broker has their quoting way. It’s up to you to transact in the market to investigate your broker’s pricing to make sure that you get the best deal. To know more about different types of Fx brokers and how they work, read our forex market news and analysis.