Forex Brokers – How Do They Make Money ?

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The advent of the Internet has not only opened up the possibility of online currency trading, but has also popularized forex trading among retail traders. However, the tremendous growth that the retail segment has been witnessing over the years can also be attributed to the benefits that forex trading offers. Some of the benefits are as follows:

#1: The currency markets are open for 24 hours in a day for five days a week. This means that you can trade forex part-time or full-time and whenever your lifestyle or schedule permits.

#2: Unlike most of the other financial markets, the currency market offers excellent liquidity. This means that you can trade large volumes without causing significant market impact.

#3: Forex brokers provide clients with leverage, meaning they can trade for values much more than their account values. This allows you to maximize your profits, but leverage has to be used with caution as it can multiply losses as well.

#4: The transaction cost (typically, the bid/ask spread) is very less for retail online forex trading.

top trusted forex brokers large accountsIn the forex market, where the trading volume is around $5 trillion a day, you can buy and sell different currencies based on whether you think the value of a currency will appreciate or depreciate. However, you need to go through an online forex broker in order to execute trades as a retail segment participant. Irrespective of whether you make profits or losses, the forex broker you are working with will make money because of the commissions and fees charged by the forex trading platform provider. It is, therefore, important that you have a clear understanding as to how the brokers make money so that you can choose the right platform for placing your trades. Identifying and working with the right broker enables you to succeed as a forex trader and achieve the financial goals you have set for yourself.

Forex Brokers – What Is Their Role In Currency Trading

The forex broker takes buy and sell orders from you and then executes them. Typically, they operate in the over-the-counter or OTC market. The OTC market is not subjected to any of the regulations that are applicable to other financial exchanges and the forex brokers are not required to comply with many of the stipulations that govern the transactions in the securities market. Further, the currency market does not have a centralized clearing mechanism. This means that you have to be very careful and wary about the fact that your counterparty does not default. This is to say that you should do a thorough background check and have an idea of the capitalization status of the forex broker you are planning to work with. It is, therefore, a good idea to always choose a reliable forex broker.

Forex Brokers – Fees and Commissions

In order to execute the buy and sell orders that you place on the platform of the forex broker you are working with, the broker would either charge a commission or a spread for each trade. This is how they make money. The spread refers to the difference between the ask and bid prices for a particular trade. The ask price is the price you are required to pay when buying a currency and the bid price is the price you would receive when selling a currency. The broker makes money from the spread, meaning difference in the buying and selling prices. Some brokers may charge a commission, in addition to the spread, on each trade. On the other hand, some brokers offer you commission free trades, but they may widen the spread on each trade so that they can make money for themselves.

While some forex brokers offer fixed spreads, some others offer variable spreads. In the case of the latter, spreads vary on the basis of the price movement in the currency market. For example, a major economic event like announcement of interest rates can lead to variations in the spreads being offered by forex brokers. As a forex trader, sometimes it may be favorable to you and some other times it may not be so. If the currency market starts experiencing volatility, you might end up paying out a great deal of money, more than what you expected to pay initially when placing the order. Another important aspect you have to keep in mind is that a forex broker may offer different spreads for buying and selling the same currency. Therefore, it is very important that you have a clear understanding of the pricing.

Typically, well capitalized forex brokers that work with several large forex dealers obtain very competitive quotes and they offer competitive pricing.

Forex Trading – What Are the Risks Involved

If you have a margin account, you can trade after depositing a small amount, which will meet the margin requirement. However, the risk involved is very high not only for the trader, but also for the broker. The risk involved when using a margin account for forex trading is best explained with the help of an example.

The Swiss National Bank refrained from supporting the euro in January 2015. This action by the bank significantly increased the value of the Swiss franc against the euro. Some traders were caught on the wrong side when trading Swiss franc – euro pair during the times. They failed to even meet their margin requirements. Some of the brokers that suffered catastrophic losses even went into bankruptcy.

Final Thoughts

If you are thinking of taking up forex trading, you need to cautiously identify the right forex broker to work with. Many forex traders have lost money in forex trading. That does not mean that you will also lose money. They lost because they fell for the fraudulent get-rich-quick schemes offered by some brokers. If you exercise some amount of caution and work with regulated brokers who are very transparent in their dealings, there is no reason why you will not succeed as a forex trader. All said and done, it is entirely up to you investigate the background and their pricing method adopted by the broker you are planning to work with.

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