Without FOREX brokers retail traders can not conduct and participate in trading activities in the FOREX Market. FOREX brokers exist to make it easier for you to connect with the banks out there that are buying and selling currencies. They act as an intermediary between you and the “inter-bank”. Inter-bank is a term that refers to networks of banks that trade with each other. Typically a FOREX broker will offer you a price from the banks that they have relationships with. Many FOREX brokers use multiple banks for pricing and they offer you the best one available at the particular time you are executing a trading transaction. FOREX brokers also offer Leverage terms to retail traders in order to trade reasonable volumes in the market, this helps us to make reasonable profits even with a small portfolio. However, if leverage is not well applied, it could be catastrophic.
We have to have it in mind that FOREX brokers are not only there to serve us for our own benefits, they are also in business to make profits as well which is the major reason anyone goes into business. Brokers officially make there money from spreads and commission which is charged for making a trading transaction. For those who don’t know what a spread is, every financial market has a spread and so does Forex. A spread is simply defined as the price difference between where a trader may purchase or sell an underlying asset. Traders that are familiar with equities will synonymously call this the Bid: Ask spread. You can determine the spread of a currency pair at a particular time by deducting the bid and the ask price by the market watch on your trading platform. However, we have to two types of spread that is been offered by brokers, namely the fixed and variable spread.
Fixed spread are spread types that are always constant no matter the present condition of the market. i.e be it during news releases or Sydney session when liquidity is low or during holidays while variable spreads are spread types that change from time to time depending on the present market condition. Each one of these has its own advantage and disadvantage but this is not the major topic of discussion. Brokers using spread model as a way of making profit only charge there commission strictly via spreads. On the other hand, commission based brokers offers account whereby they charge a side commission based on a percentage of the spread. For example, some brokers charges you a small side commission, usually in the order of two-tenths of one pip, or about $2.50 to $3 per 100,000 unit trade or even lesser. Some brokers using this side commission model still at the same time charge very low variable spreads simultaneously while some do not charge spread at all with the side commission like Instaforex who offers Eurica account types. This particular account type offers 0 spread but a side commission is charged for every lot size used to trade.
The general understanding of traders is that the increased spread model (variable spread) without a side commission is better than paying a side commission with a raw spread or no spread. From a logical perspective a trade without a side commission may look better than seeing the commission next to each trade, however traders should take into account few other considerations which will show that the general understand is not quite right. You need to first understand the fact that no matter if the broker’s model charges a side commission or not, you are always paying a commission, which is where brokers officialy make there profit from. It’s just that with one model your commission is paid by charging a fixed spread or a higher spread on each currency pair, while the other model has a much lower spread and charges a side commission.The model with raw spreads and side commission is much more transparent to the trader than the model where the commission is built in the higher or widening spread. With the side commission model, the trader always knows what commission he is actually paying and also he always sees what the real market spread is. That is why this model is also used by all top inter-bank traders and most of the big institutional traders.
The bottom line is even though you might think you are getting a deal when paying a fixed, variable spread or side commission, you may be sacrificing other benefits of each model. But one thing is certain: As a trader, you always pay commission via spread or side commission and your broker always earns it. Another major factor to consider is the type of strategy you use in trading as these would determine the best commission model for you.