How forex brokers make money?

The forex brokers’ business model is centered around playing a dual role:

• facilitating trading for investors;
• acting as a counterparty-dealer.

On one hand, forex brokers provide a platform for investors to buy and sell foreign currencies; on the other hand, they act as the counterparty-dealer, meaning they are the ones who buy from the sellers and sell to the buyers, and at certain conditions can also profit from their clients’ losses.

Typically, a classic broker acts as an intermediary, connecting buyers and sellers without taking a position in the trade. However, in the case of forex markets and CFDs, these so-called “brokers” actually do take a position in trades as they function as the counterparty to their clients’ transactions. Therefore, a more accurate term for these entities may be “dealers”. This is because they deal in the assets themselves, buying from the sellers and selling to the buyers, rather than just facilitating the execution of the trade as a typical broker would.

So, forex brokers primarily earn money through the levying of trading fees and non-trading fees. Trading fees are imposed on each transaction made by investors on the platforms, while non-trading fees usually come in the form of charges for services such as withdrawals or account inactivity.

Lastly, if they apply a B-book risk management model, forex brokers also profit from their clients’ losses.

These are the business model foundations of practically all major forex brokers in the global landscape.

Forex brokers make money not from a single method but from a bundle of activities.

Here below you can find how forex brokers make money:

• Trading against client (B-Book)
• Spreads
• Commissions
• Overnight Swap / Rollover Fees
• Back to base
• Inactivity fee
• Currency conversion fees
• Deposit and withdrawal fees
• Volume-Based Rebates
• Payment for Order Flow
• White label

Trading against client (B-Book) can be considered a type of method in its own right, as it concerns the broker’s risk management structure itself.

Spreads, Commissions, Overnight Swap / Rollover Fees and Back to Base are earnings coming from the Trading Fees, i.e., the earnings related to the trading activity of the broker’s clients. So, considering the other side of the coin, these are the items that translate most into forex trading costs for traders.

Inactivity fee, Currency conversion fees, Deposit and withdrawal fees, Volume-Based Rebates, Payment for Order Flow are instead earnings coming from the management of the trading account or from business arrangements undertaken by the broker, thus not related to trading activities.

“B-Book” is a commonly used term in forex trading that refers to a method of managing trades where the broker takes the opposite side of the trader’s position. Essentially, when the trader places a buy order, the broker takes a sell order, and vice versa, without necessarily passing the trade onto a liquidity provider to hedge the risk (a-book model).

If a trader goes long on a currency pair, the broker takes a short position on the same currency pair. If the trader’s position results in a loss (the price goes down), the broker’s short position makes a corresponding gain. Conversely, if the trader’s position gains (the price goes up), the broker’s position results in a loss. Hence, B-Book brokers profit when their clients lose money on a trade and vice versa.

From the broker’s perspective, this method can be highly profitable. Given that most retail forex traders lose money, a high percentage of unsuccessful trades lend the broker a lucrative advantage in using the B-Book model. It offers an opportunity to capitalize on these losses, particularly in situations where there’s a high turnover of customer accounts.

The spread, in the context of forex trading, refers to the difference between the buying price (ask price) and the selling price (bid price) of a currency pair. This gap existing between the ask price and bid price serves as one of the primary ways forex brokers make money.

If a trader wants to buy a currency pair, they will be quoted the ask price from the broker. Should they want to sell the same currency pair, the broker will indicate the bid price. Now, the broker pockets the difference between these two prices, which is the spread.

Among low spread forex brokers, the average spread is approximately 0.08 pips for EUR/USD, 0.13 pips for USD/JPY, and 0.29 pips for GBP/USD, indicating competitive conditions for these major forex pairs.

From a broker’s perspective, utilizing the spread as a revenue source is not only lucrative but beneficial due to its reliability. It’s not dependent on customer’s gains or losses, but rather on the volume of trades. The more trades executed by the traders, the more spreads are paid, which increases the broker’s earnings.

In forex trading, trading commission is a direct charge applied by brokers on a trader’s transactions, contrasting with earning money through spreads. This commission is typically a fixed fee per lot traded or a percentage of the volume traded.

The mechanism operates with the broker imposing a specified charge every time a trader enters or exits a trade, which is clear and upfront. For example, a broker might charge $8 per lot, and if a trader buys one lot of EUR/USD, they pay a $8 commission.

Brokers use trading commissions to generate revenue in a transparent manner, ensuring traders know exactly what their trading costs will be regardless of market conditions. This method appeals to traders using strategies that require tight spreads, as the costs are predictable and do not fluctuate with forex market volatility or liquidity.

Industry standards dictate that brokers disclose all commission structures openly, allowing traders to make informed decisions. Regulatory bodies monitor these disclosures to ensure they meet guidelines that protect traders from hidden costs. The commission model is especially common among ECN (Electronic Communication Network) brokers, who offer direct access to the forex market and typically have the advantage of tighter spreads but charge commissions on trades.

“Overnight Swap” or “Rollover Fees” are charges that traders incur when they hold a trading position overnight. This fee is either paid or earned by traders, depending on the difference in interest rates between the two currencies in the traded pair.

The mechanism hinges on the interest rate differential between the two currencies in a pair. When traders hold a position after the market closes, brokers apply a rollover fee that corresponds to the cost or gain of holding that position. The trader pays the fee if they are in a short position on the currency with the higher interest rate, or earns it if they are in a long position on that currency.

Brokers use this method as it compensates for the cost of holding positions overnight. They often add a small markup to the fee, which serves as an additional revenue stream for them. This fee reflects the carry cost of the trade, and brokers might adjust these fees to manage their risk or incentivize certain trades.

Within the industry, rollover fees are standard practice and brokers clearly outline them in their terms and conditions. Regulations ensure transparency in how brokers calculate and disclose these forex broker fees. Although practices vary globally, reputable brokers comply with regulatory standards that mandate the fair application and clear communication of any rollover fees charged to traders.

“Back to base” fees refer to charges a broker levies when a trader holds a currency position in a currency different from their base account currency and this position needs conversion back to the base currency. This fee compensates for the currency conversion that takes place.

The mechanism activates when a trader closes a trade in a non-base currency; the broker converts the profit or loss from that trade’s currency back into the trader’s base currency. The broker applies a fee or rate for this conversion, which may be less favourable than the forex market rate.

Brokers use back-to-base fees to cover the costs associated with converting currencies, as they often have to engage in the interbank forex market to facilitate these transactions. This practice also allows brokers to cushion the risks that come with exchange rate fluctuations.

Industry standards necessitate that brokers disclose all potential fees, including back-to-base fees, ensuring traders are aware of the costs associated with trading in different currencies. Regulatory bodies enforce this transparency to safeguard traders from unexpected expenses. These fees can vary across brokers and jurisdictions, but consistent regulatory oversight aims to keep the practice within fair boundaries for traders globally.

In forex trading, an inactivity fee is a charge brokers impose on traders’ accounts that remain unused for a specified period. This fee compensates the broker for maintaining the account on their platform despite its dormancy.

The mechanism kicks in when an account shows no trading activity for a continuous period, often set out in the broker’s terms and conditions. When this period lapses, the broker deducts a set fee from the trader’s balance.

Brokers use inactivity fees to incentivize traders to remain active and to cover the costs associated with the upkeep of dormant accounts. These fees are a part of the revenue model for brokers and discourage the proliferation of inactive accounts.

Industry standards mandate brokers to clearly disclose inactivity fees, allowing traders to be fully informed before opening an account. Regulatory bodies monitor these disclosures, ensuring they are not exorbitant and that forex traders have fair warning before they are charged.

Currency conversion fees are costs that brokers apply when traders deposit or withdraw funds in a currency different from their account’s base currency. This fee arises due to the need to exchange currencies to match the base currency of the trader’s account.

The mechanism works by applying a predetermined fee or percentage for the currency conversion each time a deposit or withdrawal is made, which may involve a less favorable exchange rate than the prevailing market rate.

Brokers use currency conversion fees to manage the cost and risk associated with fluctuating exchange rates when converting funds. These forex broker fees fees also contribute to the broker’s profitability by providing a buffer against forex market volatility.

Within the industry, transparency regarding currency conversion fees is essential, and regulators require brokers to provide clear information on these fees to protect traders from unexpected costs.

Deposit and withdrawal fees are charges that some brokers levy on traders when they fund or remove money from their trading accounts. These fees cover the transaction costs that brokers incur during the transfer of funds.

The mechanism is straightforward: a forex broker charges either a fixed amount or a percentage of the transaction each time a trader makes a deposit or withdrawal.

Brokers use these fees to offset the costs charged by payment providers and banks for processing these transactions. While not all brokers charge these fees, they can be a significant source of revenue for those that do.

“Volume-based rebates” are incentives that liquidity providers give to brokers based on the trading volume of trades they pass through to the market. These rebates serve as a form of commission for the fkrex broker for directing high volumes of trades to the liquidity provider.

With this mechanism, brokers make money on a tiered structure; the more volume a forex broker channels to the liquidity provider, the larger the rebate they receive. For instance, a forex broker may get a rebate of $1 per million traded if they exceed trading volumes of $100 million in a month.

Brokers use these rebates as a means to reduce their overall trading costs, passing on a portion of these savings to traders in the form of lower spreads or commissions, while retaining a part as profit. This practice encourages brokers to increase trading volume to reach higher rebate tiers.

Within the industry, it’s common for brokers and liquidity providers to engage in such rebate agreements, though they are typically behind-the-scenes financial arrangements.

Payment for order flow is a practice where a forex broker receives compensation for directing orders to particular market makers or liquidity providers.

The mechanism works by brokers routing client orders to the liquidity provider that pays them the highest rate for order flow, rather than where the client might get the best execution price. For instance, a broker might receive a fraction of a pip as compensation for every trade executed by the liquidity provider they send orders to.

Brokers favor this method as it presents an additional revenue stream without imposing direct charges on their clients. It supplements their earnings, often allowing them to offer lower trading costs or commission-free trading.

In the industry, the legality and ethics of payment for order flow are subject to debate, and practices vary widely by region. In some jurisdictions, regulators impose strict disclosure requirements, or they may outright ban the practice to prevent conflicts of interest, ensuring brokers prioritize best execution over receiving rebates.

A white label solution in forex trading refers to a practice where a broker offers its trading platform and other services under the brand of another company.

The mechanism works through a partnership where the primary broker leases its trading platform, customer support, and back-office support to another firm that wants to establish a forex brokerage service without the overhead of developing its own technology or infrastructure. From the broker’s perspective, this method expands their business and generates additional revenue streams without significantly increasing operational costs, as they essentially replicate their existing services for another brand. It benefits them by tapping into the customer bases of other companies and by collecting fees from these white-label partners for the use of their platforms and services.

In the industry, such partnerships are quite common, and they typically operate within the regulatory framework of the jurisdiction in which the primary broker is regulated, ensuring that the white label partners adhere to the same compliance standards. Regulations may require the disclosure of the actual provider of the platform to the clients, to maintain transparency in the market.

Based on the financial statements of six of the biggest players on the forex market – eToro, Plus500, IG Markets, CMC Markets, NAGA, and XTB, it can be estimated that on average, a forex broker can earn around $3,000 per client.

This figure represents the Average Revenue Per User (ARPU), which gives a numerical approximation of how much a forex broker makes per client.

In the context of forex brokers, the concepts of A-book and B-book refer to the two widely used methods for managing trades and risk.

Although this is one of the great misunderstandings in this industry, a forex broker always acts as a counterparty to every trade, even if a broker claims to be STP or ECN.

A-Book execution is a method where a forex broker transfers the market risk from trades to a third party rather than accepting it. Essentially, when a customer places an order, the broker finds a counterpart in the institutional foreign exchange market such as a bank or another broker, and enters into a corresponding trade with them, thereby creating a “cover position” or “hedge” and balancing its exposure. In this scenario, the forex broker does not profit from the trade’s gains or losses but makes money through commissions or markups on the spread.

B-Book execution means the forex broker takes on the market risk. In this scenario, when a customer places a trade, the broker takes the opposite position, internalizing the risk. This means if the customer buys, the broker sells, and vice versa. Hence, if the market moves against the customer, the broker profits, and if the market moves in favor of the customer, the forex broker incurs a loss. This form of execution can create a conflict of interest as the broker benefits from customer losses.

The B-book model is often considered more profitable for any forex broker, albeit with higher risks. This profitability stems from the fact that in the B-book model, the broker acts as the counterparty to the trades.

Since a significant proportion of forex traders lose their initial investment (estimated at 80-95% within six months), these losses translate into profits for the B-book broker.

However, this model also poses greater risks. Unanticipated market events can lead to substantial losses for the broker, especially if a large number of clients make profitable trades against the broker’s position.

This is one of the main reasons why the vast majority of brokers nowadays use a hybrid model.

In the Hybrid Model, brokers have the flexibility to handle orders in various ways. They can choose to internalize trades, hedge them with liquidity providers, offset trades with opposite orders from other customers, or use a combination of these methods.

Brokers can opt to A-Book orders that come from profitable traders to minimize their risk. On the contrary, they can choose to B-Book orders that come from smaller or less successful forex traders to potentially profit from the losses these traders incur.

The key to efficiently executing this model lies in robust customer profiling, categorizing traders based on trade size, account balance, leverage, risks they take, and their use of stop losses. Advanced software algorithms analyze and profile traders to identify patterns that are indicative of either profitable or losing behaviors. This information then guides the decision on whether a client gets A-Booked or B-Booked.

How forex brokers make money with an hybrid model?

Forex brokers using an hybrid model are essentially blending the A-Book and the B-Book execution models, which allows them to manage their risk effectively while also generating revenue in multiple ways.

When brokers implement the A-Book part of their model, they typically earn revenue through trade commissions or by adding a markup to the spread for each trade they relay to their liquidity providers. They may charge traders a set commission for each transaction or increase the spread slightly — the spread being the difference between the bid price and ask price.

On the other hand, in the B-Book portion of the model, brokers stand to gain from their clients’ losing trades. By taking a position opposite to the trader, the broker benefits directly if the trade is not successful. Considering the high rate of unsuccessful retail forex traders, this aspect can become a significant source of income for brokers.

Yes, forex brokers always act as the counterparty to your trades. Whether they use the A-Book or B-Book model, the broker always takes the opposite position of your trade. For example, if you buy a currency pair, the forex broker sells the same pair, and if you sell a currency pair, the broker buys it.

In the A-Book model, although the broker transfers the market risk to a liquidity provider by taking an offsetting position with them, they still remain the counterparty to your trade. In the B-Book model, the broker takes on the market risk themselves and directly profits or losses from the result of your trade.

Regardless of the model they use, brokers must always take the opposite position of your trade, which is why they are always the counterparty to your trades in forex trading.

Yes, Forex brokers who use the B-Book execution model do make money when traders lose. They act as the dealer and take the opposite side of the client’s trade, meaning they profit if the client loses money on their trade.

However, it’s important to note that this B-Book model also presents a risk for the broker. If the trader wins their trade, the forex broker will lose money. This happens because the broker has taken the opposite side of the trade, and any profit for the client equates to a loss for the broker.

Forex brokers do not actually want traders to lose. While it’s true that B-Book brokers can potentially profit from client losses, it’s important to understand that their business model relies on long-term client relationships. A forex broker would benefit the most when their clients engage consistently and continuously in trading forex, irrespective of whether those trades are winning or losing.

If traders lose all their money and stop trading, the broker loses a source of revenue. Therefore, brokers want clients to be successful enough to continue trading over an extended period. Even B-Book brokers prefer a scenario where they have many clients who are trading frequently with balanced long and short positions. This minimizes their market risk and allows the forex broker to profit from the spread without being exposed to significant financial risk from large trades.

There is an ongoing debate about the ethics of the B-Book model in forex trading. It’s important to clarify that the B-Book model itself is not unethical. However, the potential for a conflict of interest exists because B-Book brokers profit directly from client losses.

The ethical concerns arise when brokers manipulate trades or engage in unfair practices to ensure client losses. In a regulated and fair trading environment, a B-Book broker should provide the same quality of service, including fair pricing and best order execution to their clients, just like an A-Book broker.

At the end of the day, the perceived ethics of the B-Book model largely depend on the broker’s transparency in informing clients about their execution model and ensuring fair practices. Both A-Book and B-Book models can be considered ethical if they prioritize fair pricing, best order execution, and open communication with clients.

Technically, any forex broker has the potential to manipulate prices as a strategy to generate profits. However, this does not necessarily imply that they engage in such practices. The ultimate goal of brokers, in fact, is to encourage traders to remain on their platforms and engage in trading for as long as possible. Thus, the focus is more on fostering a conducive and trustworthy trading environment rather than resorting to price manipulations.

However, understanding the possibility of such manipulations by forex brokers is crucial for traders. Therefore, it’s always wise to opt for a regulated forex broker, as these entities operate under strict financial regulations which significantly minimize the risk of price manipulation. By choosing regulated brokers, traders can invest with an enhanced level of trust and security in the forex market.

Forex brokers generate their revenue under the stringent control of financial governing bodies. These supervisory entities ensure that brokers conduct their business in a fair and transparent manner. Therefore, any form of discrepancy that diverges from the set standards could result in severe penalties or even license revocation for the broker.

Alongside this, forex brokers are also required to comply with a set of strict rules called Treating Customers Fairly (TCF). These guidelines dictate how brokers should interact and engage with their clients. They encompass a span of practices including providing clear information, managing customer expectations effectively, and offering a high level of customer service.

These rules, which are part of the general framework of forex regulations,  serve to ensure that the rights of the clients are always upheld and that brokers are always acting in the best interest of their clientele.

Despite the absence of overnight swap rates, brokers have devised alternative methods to generate revenue from forex Islamic accounts.

In the following list, you can find how forex brokers make money with islamic accounts:

• Wider Spreads: Brokers may offset the lack of swap fees in Islamic accounts by setting wider spreads, which slightly elevates trading costs per transaction.
• Flat Fee Replacements: Instead of interest-based rollover fees, brokers might impose a flat fee on trades held open beyond 24 hours, aligning with Sharia law.
• Commission Charges: To maintain revenue, brokers could raise commission fees for trade execution in Islamic accounts, ensuring compliance with Sharia principles.
• Volume-based Charges: Brokers might also introduce charges that scale with trading volume, sidestepping interest while still generating income.

Forex brokers don’t directly make money from offering leverage to traders. Leverage in forex trading is a tool that allows traders to control a large position with a relatively small amount of capital. It is essentially a loan provided by the forex broker to the trader, allowing the trader to take larger positions and thus potentially amplify profits (and losses).

However, indirectly, leverage in forex can be financially beneficial for brokers, as it can lead to larger trading volumes and more frequent trading.

Larger positions amplified by leverage increase the size of the spread or commission, boosting the broker’s revenue. Additionally, there might be instances where brokers charge interest on leveraged positions held overnight.

Moreover, increased leverage encourages traders to trade more actively, as they seek to take advantage of minor forex market movements, which in turn generates more revenue for the broker through transaction fees.

Finally, if a leveraged trade goes sour, the forex broker may profit from the liquidated positions, particularly if they have a B-Book business model where they serve as the counterparty to the trades.

Forex brokers do not generate income directly from the bonuses they offer. Instead, brokers make money from the subsequent deposits made by traders.

After providing initial bonuses, brokers often experience an increase in trading activity on their platforms, leading traders to make additional deposits.

Therefore, while bonuses serve as an attractive incentive for traders, they also indirectly contribute to the broker’s revenue through subsequent deposits made by the active traders.

Yes, forex brokers can lose money. In a B-Book execution model, brokers can lose money when a trader’s position turns profitable because they take on the opposite side of the trade. For example, if a trader takes a long position and the currency pair’s value rises, the broker, who took a short position, incurs a loss equal to the trader’s gain.

In an A-Book execution model, brokers may not lose money directly from the trade’s gains or losses, as they transfer the market risk to liquidity providers. However, they can still face losses due to unanticipated forex market events or if they fail to secure rates from liquidity providers that are more favorable than the rates they offered to their clients.

Additionally, brokers can lose money in operational expenses and overheads, particularly if they don’t have enough active traders to cover these costs. They may also suffer losses due to system failures, compliance issues, fines from regulatory bodies for non-compliance, and various unforeseen circumstances.