Many beginning Forex traders wonder how the Forex brokers earn their money on the common traders, if they are not casinos. Understanding the basic principles of the brokers economics will help traders to distinguish real Forex brokers from the «bucket shop» scams and the ethical companies from the unethical. Here is the list of the most common ways for the Forex broker to earn money:
- Currency pair spreads. The largest source of income for the Forex brokers, spread is the difference between the Bid and Ask rates. Broker can execute your orders without a spread or with a minimal spread, earning the money that you lose for the spread.
- Leveraged spreads. Spreads alone would be too small to be a significant earning source for the brokers. So, brokers offer high leverage. Of course it is a great tool for multiplying your profit (and also losses), but the spreads are also leveraged. With 1:100 leverage, broker earns 100 times more on spreads than it would without the leverage.
- Overnight swap spreads. Brokers pay the overnight swaps to the trader if the difference between the currencys interest rates is positive in the traders position and get paid from the traders account if that difference is negative. But those payments are not symmetrical and they are changed so that the Forex broker would always get the advantage. When someone is selling 1 lot of EUR/USD and another trader is buying the same amount of that currency pair, the latter is earning money on overnight swaps, but the first one is losing the amount that is enough to compensate the second ones earnings and to «feed» the broker.
- Payment processing commission. On-line Forex brokers do not charge commission per trade (except Islamic accounts) and often advertise that as a feature. But some brokers charge payment processing fees — they are deducted only when you deposit or withdraw money and usually are quite small and fixed in currency units, not percentage points. Of course, such commissions are too small to form a significant part of the brokers profit, but they are enough to compensate at least a part of the brokers expenses.
- Trading against the trader. The most despised and unethical way the Forex broker can make money is to trade against its customers. And thats the most profitable way too. Avoid the brokers that earn when you lose. If the spreads are too low, the leverage is insignificant, the overnight swaps are fair and there are no commissions (for payment processing and trading), then the broker is certainly trading against you to make money.