How do forex brokers make money?

Within this article we will discuss in detail how forex brokers make money.

In more detail, you will find information regarding:

• The types of earnings forex brokers make
• Whether a forex broker can lose money
• The different business models of brokers
• How brokers manage users’ money

How do forex brokers make money?

Regulated forex brokers make money mainly from spreads, non-trading fees (deposit, withdrawals, currency conversion fees) and other trading commissions such as rollover fees. Then they can also make money directly from traders’ losses, or providing services to other brokers and forex traders.

Unregulated forex brokers or those without KYC, on the other hand, may also make money in illegal ways such as by front running, selling clients’ private information, or may manipulate the pricing increasing their clients’ spreads.

In this next section, we will break down each one of these forex broker fees.

Trading commissions

Trading commissions include the spread, and overnight commissions. If a broker does not charge spread commissions, it will charge commissions per lot.

The spread is simply a mark-up on the selling/buying price of the currency. For example, if the broker can access market spreads of 0.1 pip, but on the trading platform spreads start at 1 pip, it means that for each open trade the broker will earn 0.9 pip. 1 pip, in the case of the EUR/USD pair corresponds to about 10 USD for every 100000 USD traded.

When trading minor or exotic forex pairs, the broker will charge even higher spreads because the forex market is based on USD. So if you want to trade EUR/GBP with an USD account, the broker must first convert your money into EUR with the USD/EUR conversion (and this will charge spreads), then they will have to buy GBP (charging additional spreads) with the EUR he has converted.

If the broker doesn’t charge spreads (agency forex brokers for example), it may charge commissions for each lot traded. In this case, brokers offer raw spreads (i.e., market spreads), but they charge additional fixed fees based on the trading volumes generated by the trader. These are generally $7 per $100,000 traded.

In other words, if you open a position of 1 micro lot in the foreign exchange market with a broker whose commission per lot is $7, you will have to pay $0,07 in total.

Overnight fees, on the other hand, are charged once a day on each position left open overnight. Thus, if you open a forex trading position at 8pm (UTC), and leave it open overnight, the broker will charge a variable fee that generally hovers around $8 per $100,000 traded.

Non-Trading commissions

Non-trading commissions include deposits and withdrawals, as well as currency conversion fees.

Generally, brokers do not charge commissions on deposits, but prefer to do so on withdrawals. Many brokers prefer to charge a fixed percentage on withdrawals (with a maximum commission they can charge), while others prefer a flat commission for all withdrawals.

Generally speaking though, withdrawals never charge commissions above $30.

Other brokers like Pepperstone, on the other hand, don’t charge commissions at all on both deposits and withdrawals.

However, both deposits and withdrawals may charge conversion fees if these transactions take place in a different currency than that of the trading forex account.

For example, if the trading account is in USD, but the trader has a EUR or GBP bank account, money transfers may cause currency conversion fees. eToro, for instance, only offers USD accounts and it charges commissions starting from 50 pips on deposits and withdrawals in currencies different from the USD.

Market-Making

A retail forex broker is called a market maker when it acts as a counterparty for its clients’ orders. They profit from the spread and take the opposite side of client trades, this means that they make money when the forex trader loses it, and vice versa.

It should be emphasized that this does not mean that market makers (if regulated) will do anything to make the client lose money.

Market makers create the best infrastructure for traders, then those traders are responsible for their performance.

If the trader has poor performance, the market maker forex broker acts as a counterparty. If, on the other hand, the trader has excellent trading performance, the market maker may decide to delegate the risk to a third party, and earn money only from the spread or other trading fees that the profitable trader is generating.

White label services

Getting started as a forex broker requires a complex infrastructure and a network to get forex liquidity.

Established brokers such as FXCM may lend their technology and infrastructure to smaller brokers, making them able to start offering trading services.

White labels earn money through the trading volumes generated by the brokers they are “lending” their infrastructure to.

Liquidity provider services

Retail forex brokers need liquidity to reduce spreads, requotes, and increase the speed of order execution.

When a liquidity provider offers its services to a smaller broker, it earns commissions on the spread, just as a forex broker does with its traders.

Most brokers that act as liquidity providers for the forex market like XTB, are Tier-2 providers, which means they act as liquidity aggregators between smaller brokers and Tier-1 providers.

Premium services

Each broker has its own exclusive services that it offers in exchange for a subscription or commission.

Among these, we can generally find advanced orders such as guaranteed stop loss, or advanced analysis tools.

Other brokers offer VPS for trading at an additional cost, or trading courses and direct contact with a team of market analysts.

Can forex brokers lose money?

Forex brokers can lose money when they act as a counterparty in their customers’ orders. Losses may also arise from other sources such as operational costs, market conditions and bad financial practices from the broker.

They have a management system that allows them to manage this type of risk. For example, if it is too risky to counterparty a trade, they can delegate the risk to their liquidity providers.

Brokers lose a lot of money to maintain the infrastructure because they have very high internal costs of staffing, marketing, research, and also costs from partnerships with liquidity providers.

A-Book vs B-Book forex brokers: business model differences

Even though you may hear about intermediaries calling themselves “ECN forex broker”, “STP forex brokers” or “Market makers”, nowadays most brokers have a hybrid approach.

In other words, they can act as A-Book brokers (e.g. dealing desk brokers, or market makers), or B-Book brokers (such as ECN brokers).

In a hybrid approach, brokers categorize client trading profiles, sending low-risk trades to A-Book and high-risk trades to B-Book.

In other words, if a broker knows the trader is more likely to lose money than earning it, then they will act as A-book brokers profiting from the client losses and trading commissions.

If the trader is an experienced investor and is more likely to earn money, the broker doesn’t act as counterparty. So, they just profit from spreads and other commissions, while leaving the counterparty risk to other market players.

The client profiling takes into consideration a number of factors including:

• Trading history: to analyze the win-loss ratio of the trader since he joined
• Trading volume: to analyze the risk-appetite of the trader and suppose his trading skills
• Trading strategy: to analyze if the trader is using risky or conservative trading techniques
• Account size: smaller accounts may indicate inexperienced traders and vice-versa

It’s important to notice that the user doesn’t notice if he is classified as A-Book or B-Book trader: every trader gets the same treatment from the broker when it comes to transparency and trading offering.

The only thing that changes between the two, is how the broker is profiting from forex traders.

How much money does the average forex broker make?

On average, each forex broker earns about $3000 from each client over the course of its business (ARPU: Average Revenue Per User). This figure is an estimate from reading the financial statements of 6 of the largest forex brokers on the market: eToro, Plus500, IG Markets, CMC Markets, NAGA, and XTB.

In any case, this figure may vary from broker to broker depending on their business model, and the internal optimizations they have put in place.

In fact, although about 71 percent of traders lose money, brokers have to carefully balance the outflows because very often they risk losing more money than they make because of the cost of infrastructure.

One example is NAGA, which, as we have shown in this research, went from a negative to a positive balance simply by revolutionizing its approach to expenses.

Can forex brokers use clients’ money as their own?

Reputable forex brokers segregate client funds from their own.

Regulatory authorities, like FCA or CySEC, require this account segregation to protect clients against broker insolvency, mismanagement, or fraud, and to maintain financial stability within the industry.

The money deposited by traders into their trading accounts is segregated from the forex broker’s money.

Regulated brokers offer their clients segregated accounts, which are personal accounts (held in top-tier banks) that no one can access except the trader himself.

Thus, if 1,000 clients each deposit 1,000 USD into their trading account, the broker might only earn on the deposit fee, but will not earn 1 million USD.

In fact, brokers cannot use their clients’ money as their own, and uses of this kind are severely punished by regulators.