The value of a currency and how it appreciates or depreciates is very important in the foreign exchange market. Forex traders carry out their bids on the basis of their own speculations as to how the prices could take off. With over $5 trillion traded every day, the forex market is a very liquid and yet very volatile financial market. Multibank group Forex traders cannot directly operate in the forex market. To do so, they require a forex broker who allows them access to a forex trading platform such as MT4 or MT5 to carry out trades.
Certainly, forex brokers do not offer these services for free. Regardless of whether you’re making a gain or a loss as a forex trader, brokers charge fees or commissions. Many times, there may even be hidden costs involved. When you’re choosing a forex broker, it is very important to be aware of how your broker makes money.
Role of the Foreign Exchange Broker
Primarily, a forex broker has to execute purchase and sale orders on behalf of their customers. Typically forex brokers work from the OTC or the over-the-counter market which isn’t usually subjected to as many government regulations that govern other financial markets such as the stock market.
The OTC market also lacks a central authority responsible for clearing the trades. This increases the dependency on the other part involved to ensure that they do not default. Other than choosing your broker carefully, you must also do a thorough background check of the counterparty.
Forex Broker Fees
As mentioned earlier, forex brokers charge a fee or a commission on each and every trade irrespective of whether you’re buying or selling, earning or losing. This is basically how they earn money, by charging per trade or spread. A spread is essentially the difference between the price you get for selling (bid) and the cost you have to incur for buying another currency (ask). This is also commonly called broker’s spread. Your broker may charge you both or claim to offer ‘commission-free’ trades. In case it’s the latter, notice how big the broker’s spread is.
It is important to be attentive to the pricing when it comes to spread. Note whether the spread is fixed or if it varies as per market conditions. If the spread is variable, it will always change in case something big occurs such as the interest rates are hiked or lowered. As a trader, this could go both ways in your case. You could earn more or during volatile market conditions, you might find yourself paying much more to your broker. It is also helpful to learn whether your broker has different spreads for the purchase or sale of currencies.
Working with well-capitalized brokers could work in your favour as they tend to have competitive pricing.
Different Brokers, Different Service Levels
Credit Agreement
Being an OTC market implies that the major market makers, i.e banks have an equation with the various banks and price aggregators. This relationship is typically based on an organization’s capitalization and credit’s worth. The credit agreement between two parties is the only ‘guarantee’ of sorts that exists as no guarantors or even exchanges are part of this process. Hence, where your broker stands in terms of their position as a market maker, would be directly affected by their equation with banks and the kind of trade volume they process through these banks. It is often the case that tighter spreads are offered by those market players who deal with greater forex volume.
Price quotes
An effective relationship with a number of banks means a bigger number of price quotes. So suppose the brokerage can pass on to its customers 12-15 price quotes at a somewhat wider spread, it would still have an edge over its competitors. If you’re looking for a broker that can give you greater liquidity and tight spreads, a well-capitalized broker would be the right pick for you. In case you’re aware that each time you trade you receive at-the-money executions, you can choose to go with a broker that offers a fixed pip spread. Remember that you do not want to pay slippage, which is a cost you have to incur when the trade cost differs from what you predicted/expected.
Partnering with a commission broker
If you’re partnering with a commission broker, check what they’re offering before deciding whether or not a small commission is worth paying. For instance, in return for a high-end trading platform that surpasses what you may get on an average, paying two-tenths of a pip shouldn’t hurt. Other benefits such as access to experts’ advice, educational resources or even a tailor-made online trading platform may also attract a bigger commission.
Risks of Foreign Exchange Trading
Trading on margins by adding a token amount for margin requirements is lucrative but also very risky in the foreign exchange market. Both the forex trader and the forex broker could expose themselves to market risks with margin trading. Let’s go back to the Swiss National Bank incident that took place in January 2015. The bank decided to quit backing the euro peg and thus the Swiss franc grew stronger than the Euro.
Traders who had their money riding on the Euro suffered tremendous losses, some even went bankrupt as they couldn’t gain anything from the margin. Another human error that can really make or break a situation is the fat finger error, where a trader inadvertently places an order. These ‘wrong orders’ caused a 6% dip in the British pound’s value in 2016!
The Bottom Line
Exercising caution is very important in the forex trading business. This is a barely regulated market and thus falling for malicious schemes that promise great returns quickly could be detrimental. As every broker in the forex market practices a unique quoting method, one cannot expect transparency in pricing. Though you should conduct a thorough background check of your ecn brokerage, remember that your broker will earn from the spreads you pay, no matter how your trades perform. These spreads are fees or commissions are what they charge you for allowing access to the trading platforms and the various features that it may have.
