For every individual trader, forex brokers are the gate to the financial market. Without a broker, you won't be able to participate in the financial markets and grow your investment.
Forex brokers let you access trading platforms, market data, and other necessary tools for trading. Now, let's look at how forex brokers mediate traders and the market.
Lesson Highlights
- Without a broker, a forex trader wouldn’t access the market.
- Spread, trading commissions, and other account-related fees are the common revenue streams of forex brokers.
- Broker types vary depending on the type of market their clients place their trades in. Some provide direct access to the actual market, while most mirror the market to create their own.
Forex Brokers and Forex Traders
Both forex brokers and forex traders are essential for both parties. Forex brokers allow traders to access the financial market and the resources to trade successfully.
Meanwhile, forex traders' activities are the money makers for forex brokers. With the transaction fees, spread, and commission, we can say that forex brokers rely heavily on the traders to generate revenue and sustain their operations.
Spread
When trading forex, you basically buy and sell a currency pair. When you enter a position, you have a bid (selling) price and an ask (buying) price.
So, what's the spread? As the name suggests, it's the spread of the currency pair price when you open and close it. It's the difference between the bid and ask price.
Assume you enter a EUR/USD with a market condition of 1.4000 (bid price) and 1.4005 (ask price). When you go long (buy), you enter a trade at 1.4005.
With that market condition, your position spread is five pips – your broker's profit from your trade.
Commission
Aside from spreads, forex brokers also make profit by implementing commission fee on a trade. It can be fixed or may be based on the account type of the trader.
If your broker has a commission fee, they charge you for every lot you traded.
However, brokers are now racing to zero commission fees to attract potential clients. Although enticing, remember that 0% commission brokers tend to have less sophisticated services and resources.
Account-Related Transaction Fee
Many forex brokers charge their clients other fees when using their services. These fees are additional revenue stream, mainly due to other provided services and the client's violation.
This may include:
- Overnight fee: This fee is credited to traders account when a trader holds the position overnight.
- Inactivity fees: Most brokers charge their clients an inactivity fee if the account hasn't been used for a specific time frame.
- Deposit fees: Some brokers have a deposit fee when a trader funds their trading account using third-party services.
- Withdrawal fees: Most of the time, the broker charges the trader when they withdraw their account balance to their bank, card, or e-wallet.
- Margin Interest: Broker charges traders an interest fee when they leverage the trade.
Forex broker and the market
Again, the forex brokers are your gateway to access the market. The question is, do they give you access to the live market?
It depends on the type of broker you have. Some forex brokers provide direct market access (DMA). Brokers like this give full access to the actual forex market.
If you use a DMA broker, your trade is executed directly in the live forex market, and you have access to real-time prices.
However, you must know that not all forex brokers operate that way. Most of them are market makers (MM), whereas they mirror the actual market and make their own.
When you use an MM broker, your trade is not executed to the actual market. But rather, it's executed on the market they created. These brokers often have conflicts of interest against online traders because of the risk of market manipulation.
In the next lesson, you'll explore more about the DMA or A-Book brokers. You'll walk through their operation and the way they make money.
