One of the most commonly-cited reasons for getting into Forex trading is the fact that there are no up-front broker fees or per-transaction fees, as there are in the stock market. This leads many people into the mistaken impression that trading on the FX market is free. It is not. Brokers have to make a living too. They do not make trades for other people out of the kindness of their hearts; they actually do make money to take home to their families, and a fairly significant amount of it, once all the (usually small) activity charges on the (substantial) number of activities that occur each day are added up.
To understand how Forex brokers make money, it is first necessary to understand how FX trading works. On a broker’s graph of a particular currency pair, there are often a series of vertical lines. One point of any given vertical line is the “ask” price. This is the price at which investors actually sell the currency in exchange for the other currency. The other point is the “bid” price. This is the price at which investors are actually buying the currency. In between the two points is the theoretical spot price. The distance between the two points – the vertical line – is called the spread. FX brokers make their money by taking this spread; that is, the difference between the price that the buyer was willing to pay and the price that the seller was willing to take. While the spread is ordinarily fairly small, these small portions add up because of the large volume of transactions that the broker conducts on the FX market.
Different brokers charge different amounts of spread for their transaction fees. This is one of the important points to note when choosing a broker. A broker who takes a large amount of spread cuts significantly into the earnings of the investor. The investor will never quite as much as spot price on a sale, and will never pay as little as spot price on a buy, with the result that in a close transaction, the investor risks losing all the profit that would have been made. Each transaction has to have a spread that is large enough to cover the broker’s fee and also provide the investor with a profit, if the investor wants to make money.
Unscrupulous brokers can also increase their earnings by manipulating trades and betting against their clients. These sorts of activities are not strictly regulated against, due to the general low levels of regulation in the FX market. However, they are unethical and result in investors losing money unnecessarily, or at least earning less than they could have. This is why it is important to do your research before opening an account with a broker, and make sure that the broker you pick is reputable and honest. Do not simply pick the broker who takes the smallest amount off the spread; it may be worth it to pay a bit more in these minor fees in order to be assured that the broker will deal fairly with you.