What is a Forex Broker?
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Want to bet the British Pound will decrease after BREXIT? Then you’ll need to trade the USD/GBP pair. Containing every currency in the globe, the Forex market is the biggest and most liquid market in the world, with an average daily turnover of just under 4 trillion USD.
To access this market you’ll need an online broker. In order to choose the right broker to trade with, you need to understand how they work and most importantly, how they can help you.
Each broker is different and has its own qualities and downfalls. Some brokers may put a stronger focus on customer support, or low fees, while others may offer more advanced tools and resources. Knowing your investing style, and which areas you’d like your broker to be strong in, will make it easier for you to narrow down your search.
Of course, there are also things that you should be aware of when searching for your ideal broker, the industry has varying regulations, and different countries enforce stricter laws.
In this guide, we’re going to go through how Forex brokers can help you on your path to success, how they make money, and what to look out for when choosing the broker for you.
Overview & Summary
- Forex brokers essentially work as the middle-man between a trader and the interbanks, or network of banks, to enable you to buy and sell foreign currencies
- Opening a Forex trading account has become easier over the years. Now, it’s quite a simple and straightforward task, and generally only takes a couple of short steps to complete.
- A broker will offer you a significant leverage with your account, which varies in amount.
- Forex brokers traditionally made money from fees and commissions but these are now becoming a thing of the past, paving the way for a more accessible industry.
- Many brokers offer education, research materials and even centers to help guide you and prevent you from many any rookie, or even more advanced but preventable mistakes.
- Some brokers offer superb knowledge, research and customer support to help you strategize, avoid loss and grow into an expert trader.
- The Forex market as we know it today is a relatively new industry with varying regulations that can also depend on where the broker is located.
What is a Forex Broker?
Forex brokers essentially work as the middle-man between a trader and the interbanks, or network of banks, to enable you to buy and sell foreign currencies. A forex broker will retrieve prices from the banks and offer you the best price available.
Forex Brokers can also be called a retail Forex broker, or a currency trading broker. Once you have a broker, you can access the market to speculate on rising or falling prices in the hopes of making your own big Soros win – Okay, so you might not have that much funds to put down (yet), but a big win none-the-less! 😉 Institutions or large corporations can also benefit from broker services.
Understanding the Role of a Forex Broker
In order to trade, you need access to currency pairs; Brokers do just that by giving you access to the major currency pairs, including:
Along with the other G10 currencies.
You can then begin buying and selling currency pairs. For example, buying the British Pound with the U.S Dollar will require the purchase of the GBP/USD pair. Once you do this you can then try to make a profit by closing the pair when the exchange rates change in your favour.
Opening an Account
Opening a Forex trading account has become easier over the years. Now, it’s quite a simple and straightforward task, and generally only takes a couple of short steps to complete. The whole process should only take a couple of days.
To open an account with E*Trade for example, you simply choose the account type that you would like to open, then fill out their online application – it couldn’t be easier!
You can also watch E*Trade’s New to Online Investing video and discover the brokers most popular features.
Increase Your Earnings With Leverage
A broker will offer you leverage with your account, which varies in amount. This leverage can be anywhere from 10:1 to 100:1. For example, if you have $1,000, your broker may provide a leverage of 1:10 which means that you can make an intitual trade of a currency pair up to $10,000.
Don’t let this get to your head though. Traders can often forget the risks that come along with a leverage. It could increase your profits but it could also lead you down the path of a terrible loss.
Are you an Australian Forex trader? See our list of the best Forex brokers in Australia.
Brokers Commissions & Fees: A Sea Change of Accessible Trading
The broker industry traditionally made most of their revenue from commission & fees, but we are now approaching a new era with many brokers reducing and eliminating fees in a bid to remain competitive.
Not all brokers have reached the stage of zero fees yet, so you’ll need to be aware of individual fees and commissions depending on the broker. Some brokers, including Robinhood, are known for their zero fee policy, while online brokers including Charles Schwab are fast on their heels to catch up.
The spread is one way that brokers will accrue money. This is the difference between the bid and ask price of a currency pair, or in other words, the price at which to buy and sell. Forex brokers analyse the market and then offer you a price for the pair. This price usually varies slightly from the market price.
For example, if the asking price of currency is 1.15558-1.15557, the spread is 0.0001, or 1 pip. A pip is a term used to express the broker’s fee amount.
The spread is one way of determining the broker’s commission. However, some brokers offer a variable spread or a fixed spread, then take the difference between the market spread and their own spread.
A Variable Spread
A Broker would offer a variable spread to avoid the possibility of a loss, or market risk. To do this, the broker adds a fee on top of the spread, which leaves room for market fluctuations on the spread. If your potential broker offers a variable spread then you should take this fee into consideration when trading.
A Fixed Spread
If a broker is offering a fixed spread then you’ll have a pre-arranged spread no matter the currency pair. The idea is that the brokers spread will be higher than the market spread, which will allow them to profit from the difference.
Fixed price spreads are easier to work with and better for consistency when buying and selling currency pairs.
Some brokers also charge a fixed dollar commission per 100,000 unit trade. For example, if you trade 100 units, you’ll need to multiply this by .01 to get the commission price.
With this, if you are trading with margin, then you will probably be charged an interest rate for this, too.
The last fee to be aware of is an overnight holding costs. Some brokers charge this for holding an overnight position, this happen when the market is closed, which isn’t often. You won’t need to pay a fee on futures trades though, because they already have the cost built into the spread.
An Industry Move Towards Zero Fees
Commissions and fees are now becoming a thing of the past. In 2019 a slew of brokers introduced zero fees, causing an industry shift like never before; this was a drastic change for an industry that was once built on commissions, and is paving the way for a more accessible industry.
On October 1st 2019, Schwab announced that it would be introducing a zero fee policy for stocks and exchange-traded funds. This policy was directly followed by TD Ameritrade and E*Trade, and was the beginning of an end to the broker price-war that grew when the U.S Securities Acts Amendments of 1975 eliminated fixed trading commissions.
This resulted in some opportunistic brokers increasing their fees, while Charles Schwab kept theirs at a relatively good $70 per trade. This created the era of the discount broker. Tough competition and improved technology forced drops to drop and in 2019, they were down to about $5.
Robinhood, a mobile app-based broker, was a pioneer of commission free stock and ETF trading, and their success no doubt played a role in this industry move. The broker highlighted the part they played in reduced commission prices in their Ten Million Thanks post, a blog sharing their ten million customer milestone.
Other major players in the industry began offering $0 commissions in 2018. Fidelity Investment Inc. offered zero fee index funds and JPMorgan Chase & Co. offered clients 100 commission-free stock and ETF trades in their first year.
In February 2019, both Schwab and Fidelity announced that they would be expanding commission-free trades on some ETFs. Then on November 26th of the same year, Schwab announced its acquisition of rival broker, TD Ameritrade, in a bid to take on Robinhood.
This change was good for consumers, but investors who traditionally would have earned their money from commissions, were not so happy. The share prices of Schwab, TD Ameritrade and E*Trade all took a hit. A loss of commissions for Schwab will also be a loss of about $400 million in yearly revenue. So, with no commissions, how will brokers now make money?
How Will Brokers Make Money in a Feeless Industry?
Although brokers traditionally made a lot of their revenue through commissions, they still earn a lot through other methods too.
One way in which brokers can continue to take in revenue is by investing or loaning out the money that clients aren’t using. For example, the broker would take the cash that wasn’t being invested in customer accounts and put it into one of their banking subsidiaries.
Of course, customers earn interest on this too – Schwab pay traders .12% interest and .5% for accounts with over $1 million. You can earn a larger commission on other accounts, especially the brokers own accounts.
Learn How to be the Best and Avoid Loss
Forex is a landmine of an industry. It’s inconsistent, unpredictable, volatile and risky. It is also only beginning to become more accessible to younger investors and is a relatively new market for many, too.
And so, there is a lot to learn, and until you gain a good amount of experience, you’ll really benefit from some Forex courses or guidance throughout your journey to success.
Initially, beginners may be overwhelmed by currency pricing. You may not know how to create a strategy or plan to avoid risky situations and huge losses.
Education, Research and Guidance
Many brokers now offer education, research materials and even centers to help guide you and prevent you from many any rookie, or even more advanced but preventable mistakes.
TD Ameritrade have been awarded no.1 in education for the past 7 years by StockBrokers.com. There educational material includes a fully immersive curriculum, articles and videos, webcasts, a TD Ameritrade Network, and in-person events.
Saxo offers a huge range of courses, webinars and events. The FX broker understand their clients and want you to make informed decisions. Their educational material was created to help you understand and navigate the markets.
You can watch one of Saxo’s tutorials on Forex trading if you’d like to learn more or just get a feel for their knowledge section.
If you’d like an FX broker that offers solid educational material, just check out their customer satisfaction ratings.
Customer Support and Guidance
Online investing can be a lonely trek to the top. You probably won’t have a team around you, or superiors to guide you. So, when it comes to it, you may really benefit from the customer support a broker has, and many offer some superb support and guidance for newer and even more advanced traders.
Some definitely offer better customer support than others though. If you’re a beginner or think you might benefit from having a team on hand to guide you or answer questions then make sure you do some research on this area first.
Robinhood for example, don’t offer much in the way of customer support. Their FAQ’s page and automatic bot are about as far as it goes.
TD Ameritrade on the other hand offer customers support 24/7 and you can chat with one of their team members on their Mobile Trader app. The broker also offers a Virtual Investment Consultant, “Ted”, to help you with more specific queries you may have. Ted will guide you through the tutorials, investing tools, data and more.
The FX Industry’s Regulation
This is an important one. The Forex market as we know it today is a relatively new industry with varying regulations that can also depend on where the broker is located. Certain countries have stricter regulation that has been enforced by the country’s government.
Brokers regulated in the U.S or U.K will be liable to stricter regulations than most other countries.
There are two entities that serve regulation functions among forex brokers: The Commodity Futures Trading Commission (CFTC) and The National Futures Association (NFA). Both organizations make the public aware of any lawsuits they pursue against any fraudulent or potentially harmful practices a broker may have.
Be aware of smaller, possibly semi-unregulated Forex brokers. These brokers can, and have, re-requoted prices and traded against their own customers.
The regulation protects the banks participating in Forex Trading first and foremost. As the banks trading around the world take on sovereign risk and credit risk there are processes to protect them as much as possible.
Be sure to check out our broker reviews to see a broker has the tools, resources and reputation to match your needs before making a decision.
The Bottom Line
Brokers have a lot to offer traders whether you’re just starting out in the trading world or whether you’re more advanced.
Choosing the right one will help you learn, grow, avoid risky situations, and strategize along the way. Be sure to research where your broker is and the regulations they are liable to before committing, and be careful with your leverage; the possibility of a huge win also brings with it the potential for a huge loss.
There are lots of great brokers out there, just check out our broker reviews to learn more and find the perfect one for you.