Ever wondered how do forex brokers make money. We are going to share 8 WAYS HOW FOREX BROKERS MAKE MONEY.
Let’s start by understanding who is a Forex Broker.
A Forex Broker is an intermediary between traders and large currency markets participants like banks and institutions. They provide retail traders a gateway to the vast forex market where USD 6.6 Trillion worth of trades takes place every day.
We define a Forex Broker as an aggregator that brings trading platform, trading instruments like currency pairs, their live price feed, counterparties like Liquidity Providers, payment gateway, etc. together.
They provide their trader clients a fair, transparent, and wholesome ecosystem where traders can make deposits and withdrawals, trade into their favorite currency pairs seamlessly, and track their trades and performance.
And Forex Brokers do it to make money like any other business.
How do Forex Brokers Make Money?
There are several ways a forex broker can make money. Here is the list of the ways forex brokers make money.
1. Being a Market Maker or Dealing Desk Forex Broker
When it comes to ordering the execution, there are 3 arrangements a forex broker can opt for;
1.1. A Book Forex Broker
A Book Forex Brokers are those that send their clients’ trades for execution to a third party. It could be Liquidity Providers, STP, DMA, etc.
1.2. B Book Forex Broker
B Book brokers are also called Market Maker or Dealing Desk brokers.
Market Maker or Dealing Desk forex brokers are those that take the opposite side of their clients’ trade. This means when their clients lose money on a trader, brokers make profits.
Considering the fact that more than 80% (more than 97% as per our off-record conversation with some B Book brokers) forex traders make losses, it’s a very lucrative earning stream.
Let’s understand the B Book Order Execution method in little more detail and examples.
As a trader when you place an order, there must be a counterparty that is ready to take the opposite side of the trade. For example, if you are looking to BUY 1 Lot of EUR/USD pair, there should be a seller who is ready to sell the same to you.
Hope you understand that Forex Trading is a zero-sum game! This means, when you enter into a trade, your profit is your counterparty’s loss and vice versa.
So, as a forex trader, if you ever wondered if your forex broker trades against you; the answer is, yes! Your Forex Broker may trade against you if he is a Market Maker or Dealing Desk or B Book Forex Broker.
1.3. C Book Broker or Hybrid Order Exceution
But before you jump to the B Book Brokerage business model, beware that it’s a double-edged sword. You may have some clients that are really skilled at Forex Trading and make regular profits.
When they know they can make money, they trade in large volumes. Your B Book losses on such large volume trades can eat up significant profits that you make from small traders.
And believe it or not, this is more common than you can imagine. This is how most B Book traders go belly up.
Any volatile event where your B Book positions are on the losing side can just wipe your brokerage business.
But don’t worry about it! C Book or Hybrid Order Execution model can save you. C Book is an arrangement where a forex broker sends trades of a group of traders to A Book or Liquidity Providers and settles some traders of another group of traders in B Book.
When you run a forex brokerage for a couple of weeks and months, you would easily identify the group of traders who mostly make losses. Settle their trades in B Book.
And trades of profit-making traders should be sent to A Book.
And any guesses what should you do with trades of clients who you are not sure about? It’s simple, unless you are sure, play it safe by sending all the trades to A Book.
Brokerage or Commission is the conventional revenue generation method for all intermediary businesses like forex brokerage. Forex Brokerage or Commission is a pre-decided and agreed amount of money charged per transaction or trade.
In the forex brokerage business, there are two transactions with every position; one when a trader opens it and the second when the order is closed.
Let’s understand it this way; a trader buys 1 lot of EUR/USD pair and opens a long position, this is one transaction. When this open position is closed by selling 1 lot, it’s the second transaction.
The brokerage or commission is charged on both the transaction. As a forex brokerage, you can show per transaction brokerage charges or a round-trip brokerage.
And, some forex brokers decide to offer commission-free or brokerage-free trading to forex traders.
The truth about commission-free forex brokers.
You must have heard it at least once in your life; nothing is FREE in this world! So when a forex broker says they are commission-free forex brokers ask them how they make money. There are good chances that they are B Book Brokers.
Businesses are run profits.
So if you are planning to run a B Book Brokerage, you may offer commission-free trading accounts to your client.
But if you intend to run an A Book brokerage, charging brokerage or commission is a kind of a must to generate revenues.
3. Spread Charges
In Forex Trading, every currency pair has 2 prices; Bid & Ask. Bids are placed by the interested buyers and ASK price is offered by interested SELLERS. In the live market, the spread is the price difference between bids and ask price.
When a forex trader buys a currency pair, he gets it at a little higher price than the market price and when he sells it, it gets sold at a little lower price than the prevailing market price.
This extra money is called spread and goes to the forex broker entirely if they are B Book brokers. If you run an A Book brokerage, Liquidity Provider charges the spread and you may add your spread as well on top of it.
In currency pairs, the price difference is calculated in pips.
In perfect market conditions, the spread should be zero but that is hypothetical.
Spread charges can be of 2 types
Fixed Spread Charges
As the name suggests, a fixed spread is disclosed and charged with trades. This arrangement is favorable to your trader clients as even during the volatility they need not worry about changing costs due to variable spread.
Variable Spread Charges
Variable Spread Charges as indicated above are charged according to market conditions. During the volatility, price spikes can cause huge profits and losses. This can pose serious threats to brokerage businesses. This is why several forex brokers charge volatile spread charges.
4. Swap/Turnover Charges
Forex Trading is primarily leveraged trading. Without leverage, retail trades can trade into forex as the margin requirements will be in millions of dollars. Leverage is the key to a thriving forex trading market.
Technically leverage is borrowed money and when someone borrows money, they need to pay interest on it.
A Forex Broker can levy charges on positional trades that are open for more than one day. This charge is called Swap Charges or Turnover charges. It’s technically the interest on leverage (borrowed) money.
Swap or Turnover Charges are optional. Some forex brokers don’t even charge it.
5. Deposit & Withdrawal Fee
A Forex Broker may charge a small amount every time a client deposits or withdraws money. This used to be common practice back in the day but we rarely see forex brokers that charge Deposit & Withdrawal fees these days.
But if you are planning to run a regulated, fair, and transparent A Book forex brokerage business, you may have to look for every possible revenue stream and Deposit & Withdrawal Fee could be one of them.
6. Managed Fund Services
Managed Fund Services is the next-level services or value-added services offered by forex brokerage business. When they operate brokerage for quite some time, they understand the dynamics of their business especially the composition of their clients.
Some of their clients are pro traders who have trading skills to make profits while a large chunk of clients makes losing trades. There always is the risk of loss-making traders blow their accounts completely and leave forex trading forever.
Bringing them together and letting pro traders help other traders making money can open a new revenue stream for forex brokers.
The most popular Managed Fund Services offered by Forex Brokers are:
- PAMM Account (Percentage Allocation Management Module)
- MAMM (Multi Account Management Module)
- Trade Copier
Earnings: Managed Fund Services help Forex Brokers with increased volume thereby higher brokerage, spread earnings.
Forex Managed Accounts come with management fees to clients and incentives on profits earned that are paid to Master Trader. A broker may take a cut from these earnings as well.
We have discussed Managed Fund Services like PAMM, MAMM, and Trade Copier, etc. offered by Forex Brokers. Please check them for more details.
7. Offering Liquidity to small Forex Brokers
If you grow as a large forex broker and have a large client base, you could be generating huge organic volume within your client base.
You may want to be a liquidity provider to other small forex brokers. This will bring additional trading volumes and you can earn on spread and swap charges that other liquidity providers charge.
8. Charging for Algo Trading or running EAs
There are many forex brokers that offer a separate trading account that allows traders to run Expert Advisors and do algo trading. These are resource-intensive services and you can charge extra for it as a forex broker.
A Forex Brokerage business like any other business is run for profits and profits come from the revenue.
As a Forex Broker, you can deploy all the revenue methods explained above or a mix of them.
Some of these charges can be shown but waved off or discounted as a promotional campaign to acquire a large client base.
What works best for one forex broker may not work for other brokers so don’t copy others blindly.
Analyze your client base, their requirements, pocket size along your costs, and see the equilibrium where most of them fall in place and keep you profitable.
A last but not least; as a forex broker, always be transparent about the charges to your clients. They should always know what they are going to be charged for on what conditions.
Wish you success!