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The idea with forex trading is simple; traders and speculators only buy and sell various currency pairs depending on whether the currency will increase or decrease its value.
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Trading forex is a risky affair with over $5 trillion daily transactions circulating.
Therefore, with that huge amount of transactions taking place, forex brokers come into the picture to serve the traders as an intermediary in executing exchanges.
Like it or not, the forex brokers are a significant part of every trader, and therefore, understanding how they operate and how they make money is a no brainer.
Most the broker advertises not charging commissions on trades; forex is not a casino after all.
But then how do they earn their money? Or they’re doing all the work out of their goodness of heart?
One thing for sure, forex brokers make money-and good profits. Now, the big question is, how?
Who is a Forex Broker? What is their Role?
Typically, forex brokers play their role of buying as well as selling currencies and execute the trades.
Unlike other financial markets, the forex market doesn’t have regulations, and hence the broker is not exposed to several rules.
Furthermore, since the OTC market lacks centralized clearing mechanisms, a trader has to be extremely vigilant when choosing the forex broker.
How Brokers Earn Money
Spreads
One of the ways brokers make their money is through charging a commission (spread) per trade.
A spread is the difference between the bid and ask prices of a trade. The spread is sometimes fixed or can be variable.
A broker can access lower spreads and then can as well add a mark-up to a spread before getting the quotes to traders. Therefore, a broker can earn money lost by traders on the added spread.
Commissions/Fees
Apart from the spread, some forex brokers may as well charge traders a fixed commission or fee for each trade.
ECN brokers usually have this type of scenario. However, the fees and commissions are relatively low because of the high competition among the forex brokers.
Trading Platform
Another significant income source for forex brokers is trading platforms. Most brokers offer the trading platforms for free, and others charge for the additional features.
Therefore, as a trader, all you need to do is to look at the trading platform a broker offers and look for the extra features that could be helpful in trading.
The additional feature has to increase your profitability as well as efficiency than the cost of the service itself.
Leverage
Sometimes spreads on small positions can be observed as an insignificant income source for a forex broker.
Therefore, most brokers offer high leverage, which is suitable for a trader as it increases the profits or losses.
However, trading with 1:100 leverage means that a broker can earn 100 times on spreads than it could have been without leverage.
Processing Commission
As much as most brokers don’t charge commissions for trades, some charge payment processing fees, which are deducted only when a trader deposits or withdraws money. However, fees of that kind are very small and don’t count much into a broker’s total profit.
Trading against the Trader
Some call it a myth, but another way that brokers may be making their money is by trading against their customers.
In fact, it’s the most profitable route for brokers. However, such brokers should be avoided at whatever cost.
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The Bottom Line
The forex market promises a lot of profits, but it requires a lot of caution before stepping into the market. As a trader, dealing with a forex broker is inevitable on a daily basis.
Therefore, once you get a clear understanding of how forex brokers make their money, you’ll have all the knowledge in selecting the best of them all.
Moreover, you’ll stand a chance of making profits on your trades as you’ll be trading the markets safely as well as intelligently.
