What is a Forex Broker?
A Forex Broker is the name given to an Investment firm that allows you to trade the currency market, acting as an intermediary between you and the interbank market or another intermediary broker. This service is provided to each client, by the Forex Broker, via the internet on a Forex trading platform, which allows clients to place and execute orders based on their predictions on the future movement of a specific currency pair. Most Forex brokers, in addition to providing their services for trading currency pairs, also allow their clients to trade a range of other financial instruments, including Commodities, Stock Indices, Energies and CFD’s.
This may sound a little confusing so simply understand that a Forex broker means an entity that stands in between the private trader (you) and the Forex trading market. Its main function is to receive your wanted/requested transaction and then execute it in the forex market. Forex Brokers will provide you with reliable and user friendly software, through which you may send a request to execute a certain order. As such the foreign exchange market is what is often called over the counter (OTC), as there is no formal exchange center like in the case of shares, only the interested parties that wish to buy or sell currencies make up the Forex market.
The coming about of the retail Forex brokers has been a result of the increasing demand for normal individuals worldwide to participate in the world of Forex. As of just 10 years ago, the majority of Forex market participants were banks, funds and wealthy individuals who traded in the Forex market with much wider spreads than individuals are nowadays accustomed to. Back then as liquidity in the Forex market was limited (due to the limited number of Forex brokers in existence and the limited number of market participants) a spread of 23-30 pips may have been a rational.
How are Forex Brokers categorized?
There are many categories with which Forex brokers may be differentiated, with the most important one being if the Forex Broker is regulated or not. A Forex Broker may have a license obtained through a regulatory body, a measure which many Forex Brokers take as investors are primarily interested in opening accounts with such (licensed) Forex Brokers due to the implication that such a Forex Broker abides by a strict set of rules and guidelines as imposed on him by his regulatory authority. By being a regulated Forex Broker, it means that the investors money will be safer and fraudulent activity by a Forex Broker will not (should not) take place.
The two most commonly known, and trusted, regulatory commissions for Forex Brokers in the Forex industry are the NFA (National Futures Association) of the USA and FSA (Financial Services Authority) of the United Kingdom. Should a Forex Broker be licensed by either of these 2 commissions (or most other commissions) you should be aware that your investment and the Forex Broker’s trading practises are to the highest standard as per the implications of the way in which the Forex Broker must operate further to the regulation under such regulatory bodies.
Other ways in which Forex Brokers are often categorized is by the amount of Leverage they offer (ranging from 1:1-1:1000); a tool used in which your investment may be amplified in the aim of increasing your gains. Forex Brokers may also be catogorized depending on the type of Forex broker they are – Market Maker (MM), Straight Through Process (STP) and/or Electronic Communications Network (ECN). Forex Brokers also may be seperated according to the type of spread they offer; either Fixed or Variable spread.
How does a Forex Broker make money?
The way in which a Forex Broker makes his money will depend on the type of Forex Broker they are and their ethics and execution methodologies. The main ways in which a Forex Broker can make money are listed below:
Spread – Many Forex brokers will add onto the spread they obtain from their liquidity provider and as such every time a client makes a trade, the Forex Broker will be benefitting from this trade, regardless of whether the Client wins or loses. Ways in which Forex brokers may further benefit from spreads is by offering a higher leverage, which when used means that you will be opening a larger position and the Forex Broker will be benefitting more through the spread.
Commission – Some Forex Brokers will charge a certain amount of commission per trade or per a certain amount traded. Such Forex Brokers typically have lower spreads and may be more favorable due to this as they do not benefit from client’s loses.
Trading Against the Client – Some Forex Brokers may choose not to cover a client’s position and as such when the client loses, the whiole amount lost goes into the pocket of the Forex Broker. Such Forex Brokers are often despised in the Forex Industry, however they are the most common Forex brokers nowadays due to the much larger profit that may be made in not covering a client’s position as the majority of traders, unfortunately, lose.