In this article we will explain not only what a forex broker is, but also much more about the forex broker industry.
You will be able to find out things like:
- How forex brokers work
- Why forex brokers are necessary
- How forex brokers make money (and how much they make)
- How to check a broker’s regulation
- How many brokers there are in the world and how to choose one
Table of Content
What is a forex broker?
A forex broker is an intermediary, that is, a company that acts as a conduit between people and the financial markets, specializing in facilitating trades between different currencies.
Thanks to the emergence of CFD derivatives, to this day forex brokers offer not only forex trading but are true multi-asset brokers, that is, intermediaries that offer more than one market on which to trade.
The goal of using a forex broker is to trade several currency pairs for the purpose of making a profit from the difference between the buying price and the selling price.
What does a forex broker do?
The role of a forex broker is to enable the individual user to be able to trade the financial markets by putting him or her in contact with the international interbank market, as the average trader could not trade forex in any other way.
In the world of forex trading, it is common to open positions with volumes in excess of US$100,000, and this involves getting in touch with liquidity providers to complete the trade.
However, these liquidity-providing companies only work with large financial institutions that move large amounts of money such as banks and brokers.
Why do you need a broker for forex?
It is necessary to rely on a broker to trade forex because the international interbank market is inaccessible to the average trader because large amounts of money are required to access it.
Therefore, forex brokers use several strategies to enable traders to communicate more or less directly with the financial markets:
The first method is to compact together similar, small-volume orders from hundreds of traders. In this way it manages to create a single order of sufficient volume to present to its liquidity providers.
The second method does not require the bundling of orders, but is used when a user comes up with an order of sufficient volume. This case can occur when the trader uses leverage, which is a tool that can increase the user’s gains and losses through a “loan” granted by the broker that then increases the volume of the trade.
How do forex brokers make money?
Brokers make money in a variety of ways, but generally their revenue is made up mostly of the spread and trading commissions, while a smaller portion of the revenue is made up of operating costs such as overnight fees and deposit and withdrawal fees.
The larger and more established forex brokers also manage to make money by providing white label services, that is, by “renting” their technology to smaller brokers and financial entities.
The mark-up on the spread is a fee built into the market spread. For example, if the market spread is 0.1, the broker manually adds 0.9 bringing the total spread to 1 pip.
The commission on trading is applied when the broker does not charge a mark-up. This commission is generally applied at the opening and closing of the trading position.
Overnight commissions, or rollover commissions, are interest charged when a trader leaves a derivative position open after the market closes. These commissions are typically a few cents, but they vary depending on the volume of the position-the higher the volume, the higher it will be.
Some brokers charge commissions when you deposit or withdraw money. Typically deposits are on a percentage basis, withdrawals have a flat fee.
When you deposit/withdraw or trade an asset in a currency other than the currency of your trading account, the broker may charge a conversion fee.
How much do forex brokers charge?
Forex brokers charge different commissions depending on their company policy.
Below, however, we have created a hypothetical scenario in which the user creates a $2000 account and opens a standard trading position, also simulating deposit commissions.
|Buy (1 lot)||1 pip||$10||$1970|
|Keeping it open||Rollover fee||$1||$1969|
|Close (break-even)||No fee||$0||$1969|
Certainly, this is a hypothetical case, and one must take into account that both the spread and the costs on the deposit are often lower than those presented in the table.
Do forex brokers ever lose money?
Forex brokers can lose money on several occasions.
If brokers act as market makers they act as a counterparty to traders at all times. This means that when a trader makes money, the broker loses money.
However, it should not be forgotten that brokers are companies with operating costs, and these include:
- Cost of servers
- Cost of personnel
- Cost of marketing
- Research costs
These are the most impactful costs as demonstrated by Naga, a broker that had been steadily losing money for years due to the large sums invested in research and personnel.
How to check if a forex broker is licensed
In order to check if a forex broker holds a licence, is to follow these steps:
- Visit its official website
- Scroll to the footer
- Find the company information
- Look for information about their regulation
- Double-check them onto the regulators’ official website
Your first step is to simply head over to your brokers’ website. Below you will see that we have used Oanda as an example.
Once you are on the homepage, the next thing for you to do is scroll to the footer which is at the bottom of the homepage. Here you will typically find information related to the company like their registered business name. You should also take care to select the correct world area based on your location since many brokers will display different information for different regions.
As you will see in the example below, you can locate the business name and regulator in this area of the site. You will need this in the next step. For our example, we can see the Oanda business name is OANDA Europe Markets Limited, and the Europe regulator is MFSA (Malta).
Now you are ready to bring the information you have collected to the website of the regulator mentioned. In this case, we would visit the official website of MFSA though almost all regulators have a similar register. Once there, you will use their search function to locate the broker.
As you will see, once you search the business name on the regulators’ site, or a more simplified name like “Oanda” if you can’t locate the business name, a number of results should appear. Using these results you should be able to click on each one to see more information about that regulatory license.
The information displayed below is what was found in relation to our Oanda example with MFSA regulation.
How many forex brokers are there in the world?
As of today, there are over 300 forex brokers available around the world, but only a smaller percentage of them are regulated, legit and compliant.
In fact, local regulators ban dozens of unregulated forex brokers from their territory every year.
There are more than 50 regulated forex brokers on the market, and each serves different categories of traders.
If you are interested in choosing one of the best, we have compiled a top10 with the best forex brokers in the world.
How to choose a forex broker
The choice of forex broker should depend on one’s trading style.
However, there are common factors that all traders look for in their forex broker:
- A solid regulatory environment
- Transparency and reliability
- Low trading spreads and commissions
- Commission-free deposits and withdrawals
For a comprehensive list of factors, we have created an article that explains in detail how to choose a forex broker.
If, on the other hand, you are looking for a tool to help you choose a broker, you can use our search tool, which, depending on the answers you give, the tool will return you a list of forex brokers you might be interested in.
About The Author