When entering the Forex market, you typically don’t think about how your service provider, also known as a broker, makes enough money to fund its products and services. You usually care more about how you can optimize your trades so that the profits are flowing in and losses are reduced as much as possible.
However, knowing the exact sources of money income of the broker can have a world of effect on your financial stability. If your broker is transparent about how it makes money, then you know that there won’t be some hidden fees or fraudulent activities that can potentially destroy your whole account.
In this article, we will cover both traditional and alternative sources of income for Forex brokers, be it spreads, commissions, or other fees.
The main sources of income
The first main source of income for Forex brokers is spread. A spread is the difference between the bid and ask prices and often is the only in-trading commission that you’re going to get from your broker.
Let’s have a real-life example to understand spreads better: say you’ve bought a EUR/USD FX pair at 1.3456. What this means is that one euro can buy 1.3456 US dollars. But if you were to sell the same pair at that exact time, the price would not be the same. Your broker would very likely give a lower price for it like 1.3454 or something like that. The higher price, the one at which you bought the EUR/USD pair, is the ask price, whereas the lower price at which you sold the pair is the bid price.
If there is spread, the bid price will always be lower than the ask price. The difference between the two prices is what constitutes the spread and brings revenue to the broker. In the above-mentioned example, the spread would be 2 pips: 1.3456 – 1.3454 = 0.0002. Pips are mostly counted in fourth decimals (fourth place after the dot), but you’ll also see JPY pairs whose spreads are counted in the second decimal.
So, spreads are the main way brokers make money. There are also other in-trading commissions that some of the top online Forex brokers charge – transparently, obviously. These fees don’t have specific names, they’re just commissions charged per round turn. While spreads may be fixed or variable, commissions are always fixed by the broker, which may be beneficial for some traders while for others, it may not.
Usually, brokers either charge one type of commission or the other; some mostly focus on bid/ask spreads and remove all other fees, whereas the others reduce spreads down to zero and capitalize on fixed commissions. You may also see the two charged simultaneously but such brokers are quickly dying out due to current low-commission requirements.
What you may also see is a broker claiming to be both spread- and commission-free. While they may seem the most obvious choice for all traders, you should keep in mind that no entity, be it a Forex broker or a car dealership, works for free; they need some sort of revenue – and subsequent profit – to support the business and keep offering the service. And if the broker says it doesn’t do that, then it is lying right to your face and you should stay away from them as far as possible.
Other income sources
Besides spreads and fixed round-turn commissions, there are other sources of income that brokers may have. But before listing them, it’s important to note that it doesn’t matter whether a broker charges alternative fees, it still has to have spreads or commissions on trades to be considered transparent and safe enough.
One of the biggest alternative fees that you’ll be paying is going to be a margin. When you want to place a new trade, you can do two of these things:
- Deposit the exact amount of your trade and go full-in
- Deposit a small amount of your trade and use the margin account to cover for the rest
The process of increasing your capital reach through such “loans” is called leveraging. Through leverage, you’re basically getting a loan from your broker for just a fraction of money on your part. And when you use the leverage, you’re increasing your upcoming profits, as well as profits received by the broker.
Other alternative fees charged by Forex brokers may constitute commissions for exclusive features like trading signals, ideas, educational materials, and other research-related features. But these commissions are obviously optional and if you have sufficient knowledge and experience in Forex, you probably won’t need to pay for those features anyway.
Then there are rollover fees charged for overnight trades. Basically, if you decide to leave your trade open for longer than a day, you’ll be either charged or credited a certain commission. The amount of commission is counted by the interest rate differential between the two currencies in the pair. If the interest rate for the bought currency is higher than the sold currency, the broker will actually pay you the swap, whereas the other way around would get you to pay for the rollover trade.
Pick a broker that is transparent
Finding a legit brokerage can have no less significant effect on your trades than, say, your prior trading experience. If you choose the company that claims to have no spreads and no commissions, it’ll be more likely that it charges hidden fees or uses fraudulent schemes to get money from you.
Conversely, a broker that openly says that it charges a certain amount of spreads/commissions is much more likely to maintain the same fee levels. You may also find brokers that have both of these fees but they’re quickly becoming rare to find on the market these days.
The point here is that a transparent broker is a better partner for you than one that hides the most important trading details from you.