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What Is a Forex Broker: Comprehensive Guide

10 March 2020 No Comment

It’s no secret that the forex market is the largest and most liquid market in the world. What you may not know is how to make money on it.

First things first: to access this market, you must get an account with a forex broker. Choosing the right broker to trade with is the most important decision you’ll make. That’s why you need to understand how they work and how they can help you.

Of course, this is easier said than done. Every foreign currency broker comes with advantages and disadvantages. Some focus on customer support, others advertise their low fees, and many offer advanced resources.

Want to make sure you’ll choose the right FX broker for your needs? Here’s a quick guide to their role in the industry and what to look out for.

The Role of a Forex Broker

Forex brokers work as middle-men between you and the interbank. This is another word for a network of banks that trade with each other.

A forex broker has access to all major currency pairs. For example, if you think the British pound will keep falling after Brexit, you may want to trade the GBP/USD pair. Many brokers also allow you to trade emerging market currencies.

Trading revolves around buying a currency pair and selling it for profit. In the above example, this amounts to buying British pounds using U.S. dollars. Once the exchange rates flip in your favor, you’d close the trade by selling the pair.

Accounts and Leverage

Back in the day, opening a forex account was an exhausting process. Fortunately, foreign currency brokers have since improved their client services.

The whole process is a lot like opening a bank account. You’ll need to provide the right paperwork and go through identity verification. This shouldn’t take longer than a few days, and most brokers allow you to get everything done online.

While you’re setting up your account, the broker will offer you leverage. This varies in amount, and it can be anywhere from 10:1 to 100:1. With a 10:1 leverage, you’d be able to trade $10 for every $1 on your account.

Depending on your trading abilities, leverage can be both good and bad. It allows you to make exponential profits, but it can also lead to spiraling losses. If you’re new to forex trading, it’s recommended you take things a bit slower.

Broker Commission

Traditionally, brokers make their revenue from fees and commission. That said, a recent surge in competition has led many brokers to cut most fees.

The bid-ask spread is one way for a broker to make money. When you open a trade, your broker will pass it through to the market. They then analyze the market and offer you a price that usually varies from the market price.

For instance, let’s assume you’re trading a EUR/USD currency pair. On your form, this pair may show up as 1.3500/1.3505. The first number is what your broker gives you if you sell the pair, and the second is what they charge if you’re buying it.

That difference of 0.0005 is also known as 5 pips. A pip is the most popular term that we use to express the broker’s commission. Depending on supply and demand, their commission may narrow or widen.

Spread Types and Other Fees

There are two main types of spread: variable and fixed.

With a variable spread, your broker adds a fee on top of the bid-ask spread. This leaves some room for market fluctuations, which lowers your market risk. If you’re using a variable spread, you should consider the fee when trading.

A fixed spread means having a pre-arranged spread regardless of what you’re trading. In this case, the broker’s spread will always be higher than the market spread. This difference is how they make their profit.

Some brokers charge a fixed commission per every 100,000 unit trade. To get the exact price, multiply 100 traded units by 0.01. Some brokers also charge for holding an overnight position when the market is down.

Industry Changes

As we mentioned above, the industry is going through major changes. In 2019, big-name brokers introduced a zero-fee policy for stocks.

The change began to take effect on October 1st, when Schwab announced the new policy. This led to an immediate price war, with E*Trade and TD Ameritrade following suit. By the end of November, Schwab had acquired TD Ameritrade.

Most experts agree that this change was a result of Robinhood’s success. Robinhood is a mobile app-based broker that introduced commission-free stock. Some other key industry players also began to offer zero-fee index funds in 2018.

For consumers, this change has been good. Investors that relied on commission took a hit in share prices, but they’re focusing on other earning methods. As an example, most brokers offer to invest or loan out the money their clients aren’t using.

Rules and Regulations

This is the final thing you should consider before choosing a broker. The forex market is new, and some countries have stricter regulations than others.

There are two entities that can help you verify a broker’s reputation. These are the National Futures Association and the Commodity Futures Trading Commission. If you want to research a certain broker, this is the place to start.

Trusted forex brokers also offer certain tools you can’t get everywhere. For instance, some brokers allow prospective clients to use a practice account. These require minimal information to open and can be a great practice opportunity.

Keep in mind that the forex market is always open. This means that your broker of choice should be able to provide 24-hour customer service. One way to check what kind of service a broker provides is to give them a quick call.

More on Choosing a Foreign Currency Broker

Whether you’re a novice or a veteran, brokers have a lot to offer you. With their help, you can grow, learn, and avoid risky situations along the way.

One last piece of advice: pay attention to a prospective broker’s trading platform. It should be easy to use, visually pleasing, and allow access to technical tools. Look for an interface with clear “buy” and “sell” buttons — this makes trades much easier.

Want to know more about picking the right foreign currency broker? Trying to brush up on your knowledge before starting your trading adventure? Check out our Investing section!

 

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