In the forex market, traders and speculators buy and sell various currencies based on whether they think they will appreciate or depreciate in value. The foreign exchange market is very risky, with a daily trading volume of more than $5 trillion. Traders must go through an intermediary such as a forex broker to execute their trades. Regardless of a trader's profit or loss, forex brokers make money through commissions and fees, some of which are hidden. Understanding how forex brokers make money can help you choose the right one.
Role of Forex Brokers
Forex brokers take orders to buy and sell currencies and execute them. Forex brokers usually operate in the over-the-counter market. Unlike other financial exchanges, the over-the-counter market is not regulated, and forex brokers may not be subject to many of the rules that govern securities trading. In this market, there is also no centralized clearing mechanism, which means you have to be careful that your counterparty does not default. Always research the counterparty and their funds before you proceed with the transaction. Choose a reliable forex broker carefully.
Forex Broker Fees
In return for executing buy or sell orders, Forex brokers will charge a commission or spread on each trade. This is how forex brokers make money. The spread is the difference between the bid and ask price of a trade. The bid price is the price you get for selling a currency, while the ask price is the price you have to pay to buy a currency. The difference between the buy and sell prices is the broker's spread. Brokers can also charge both commissions and trades on trades. Some brokers may claim to offer commission-free trading. In fact, these brokers are likely to earn commissions by widening the spreads on trades.
Spreads can also be fixed or variable. In the case of a variable spread, the spread will vary according to market movements. Significant market events, such as changes in interest rates, may cause changes in the spread. This may work in your favor, or it may work against you. If the market fluctuates, you could end up paying a lot more than you expected. Another aspect to be aware of is that forex brokers may have different spreads when buying a currency and when selling the same currency. Therefore, you have to pay close attention to the quotes.
Generally speaking, those brokers who are well-capitalized and cooperate with many large foreign exchange dealers to obtain competitive quotations usually provide competitive prices.
Foreign exchange trading risk
Margin trading can be realized by depositing a small amount of margin in accordance with margin requirements. This poses a great deal of risk to both traders and brokers in the forex market. For example, in January 2015, the Swiss National Bank dropped its peg to the euro, leading to a sharp appreciation of the Swiss franc against the euro. In related transactions, traders who bet wrongly lost money and failed to meet margin requirements, causing some brokers to suffer catastrophic losses and even go bankrupt. Inexperienced traders can also make "fat finger" mistakes, such as the one that sent the pound down 6 percent in 2016.
Conclusion
Those contemplating trading in the Forex market will have to proceed with caution, in this poorly regulated market, fraudulent enrichment schemes promising high returns have cost many Forex traders. The foreign exchange market is not a price-transparent market, and each broker has its own quotation method. This requires traders in this market to research their broker's quotes to make sure they are getting a good deal.
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