How Do Forex Brokers Make Money From Orders?
Forex brokers make money from all orders using a basic concept called ‘Slippage’. Slippage refers to the difference between the price at which the order should have been executed and the price it was actually executed at. It can occur because of news events that have increased the volatility of the market and have made a certain order’s execution impossible. When slippage occurs, the traders and brokers execute the trade at the next best available price.
In case of stop loss orders, brokers make money by increasing the slippage. Slippage would occur when the stop loss order was not executed at the specified price but at the next best price. There are many dealers and brokers who routinely take some pips of slippage out of the trader’s stop order. This would especially be the case when the market traded in the same direction and made the rate of the order further attractive than the current rate, even after including the slippage. Using a similar concept, brokers and dealers can also make money on take profit orders.
- Another way of making money for dealers and brokers is to sell the order flow to a market maker. This adds money to their pockets and also benefits the market maker.
- It could, in fact, result in mutually cancelling orders. Also, for the market maker, there is the added benefit of finding out the intentions of speculative traders, allowing them to place take profit orders ahead of the traders and make additional profit by triggering stop orders.
What Are Spreads And How To Brokers Deal In Them?
Because the Forex market is largely unregulated, the spread is what Forex brokers and market makers earn in exchange for providing liquidity in the market. When a trader chooses a Forex breaker, the best offered spread is chosen and it depends on the broker’s contacts with liquidity providers. If the spread is tight, the costs of the trader come down considerably. You can compare the different spreads of popular brokers at EarlyBull.
The ask rate is the buying rate that the trader can get and the bid rate is the selling rate. The difference between these two rates is called spread. In case of active pairs, the spread can be as little as 1 pip with good Forex brokers or it can be as high as 5 pips. Since many Forex brokers base their commission structure on the spread, sometimes a few pips of commission are added to the spread. The brokers get one rate from their liquidity providers and then, they offer a spread – either variable or fixed – to their traders.
For instance, in case of EUR/USD = 1.35640/35, the buying rate or ask rate is 1.35640 and the selling or bid rate is 1.35625. The spread is 0.00015. Since pip is expressed as the 4th point after decimal, the spread is 1.5 pips. It is important to mention that spreads change in the real Forex market. They are determined by factors of demand and supply, which keep changing. There are many other market factors that affect spread at the basic level. Then, as commissions and fees are added, the actual spread offered to a trader by a broker increases further.
Are Currency Options Offered By Forex Brokers And What Do They Entail?
Options are offered by Forex brokers and they are hedging tools. Options allow the trader to make gains from currency trading without actually trading in a currency pair. Also, options can be used for limiting losses and locking in profits from a trade. Since writing and trading in options is a high risk activity, large sums of collateral capital is needed before brokers allow their traders to write them. Options are a right to trade in a currency pair and not an obligation.
Option trading is not offered by all Forex brokers, though, and before traders choose a broker, they should research whether options are traded by the said broker or not. There are two basic types of options – call and put. Call options allow the trader to buy a currency pair at a set price (strike price) at a future date. Put options allow the trader to sell a currency pair at a set price at a future date. If the current rate makes the options worthless or out of money, they will just expire, and the only cost that the trader incurs would be the one spent in buying the options, nothing more. However, in case the options turn out to be profitable or in the money, the cost of the options would have to be reduced from the final profits that the trader makes from the trade.
- There are SPOT options as well which have a set condition, such as the currency exchange rate after 30 days or so, and if the condition is fulfilled, automatic payout of the option takes place. This means that the option converts into cash automatically.
- Even with options, various strategies like straddle, strangle, spreads et al are used where multiple options with multiple strike prices and expiration dates are purchased.