How Do Forex Brokers Make Money?

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’s 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 currency’s interest rates is positive in the trader’s position and get paid from the trader’s 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 one’s earnings and to «feed» the broker.
• Payment processing commission. On-line Forex brokers don’t 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 be a part of the broker’s profit, but they are enough to compensate at least a part of the broker’s expenses.
• Trading against the trader. The most despised and unethical way the Forex broker can make money is to trade against its customers. And that’s 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.

Forex: Keeping It Simple

Keeping everything simple is a nice strategy in almost all types of activities. Sometimes, simplicity is the only way to become profitable in the Forex trading. Of course, not everyone likes to keep everything simple and not everyone should do that. But simplifying some basic aspects of the Forex trading will help you to avoid unnecessary problems and complications:

1. Simple trading strategy can be as profitable as some really complex systems. By keeping your strategy simple you make it easier to follow and execute it. Adding complexity in the future can be your next level, but trading with a simple strategy is a very good way to start trading on Forex for real.
2. Try to follow a simple money management system — trading with a fixed percentage of your account equity is easy and effective. Martingale system isn’t simple and leads to losses. So, with money management simple is almost always good.
3. Fundamental analysis is a nice tool, but it’s better to avoid reacting on all fundamental news you hear. Keep it simple — select only really important releases or indicators and monitor them when you trade.
4. One of the best ways to simplify your Forex trading is to hold the open positions for a fixed amount of time. This way, your positions are limited not only with the stop-loss and take-profit levels, but also with the time limit. I prefer limiting them to 30, 60, 360 minutes and 1 week periods, depending on the particular strategy.
5. Try not to trade on currency pairs with the base currency different from the one, in which your account is founded. For example, if you trade USD/JPY, while your account is founded in USD, your profit or loss can’t be adequately measured, because it inversely depends on the USD/JPY rate.
6. Look for a Forex broker with the fixed spreads, because trading with the variable spreads can’t be easy. You can’t rely on your strategy, especially if it’s a short-term strategy, if you don’t know the spreads values for sure.
   

Some traders adore simple approaches to the market, while others hate everything that’s easily understood by high-school graduate and prefer complexity. If you think that you are the one from the first group, then this list will probably help you. If you know some other ways to simplify Forex trading, please, leave a comment to this post.