Brokers are a big part of the forex industry since they facilitate trades between market participants. They can earn vast amounts of money given the widespread popularity of forex. But do forex brokers ever lose money?
Forex brokers lose money if they trade against their clients. Their main source of income is spreads charged on each trade. So, they don’t lose any money because they earn their spreads regardless of market movements. However, if they take the other side of the trade, they lose when the trader wins.
This article will elaborate on forex brokers’ income sources and how they may lose money. It also lists different kinds of brokers who may lose by trading against their clients.
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How Do Forex Brokers Earn Money?
The most important income source for forex brokers is the spread, the difference between the ask/bid prices. In other words, brokers earn money from the difference between a currency’s selling price and the one a trader has to pay. Some brokers charge fixed spreads while others offer variable fees depending on market changes and events.
For example, if you take a position on EUR/USD at 1.1036, 1.1040, respectively, the spread will be four pips. Pips are units of measurement for the spread and small movement units in currency pairs’ prices.
Variable spread fees depend on the number of orders. The higher the order, the wider the spread. So, brokers can take advantage of high-volatility conditions by increasing the spread.
In addition to spreads, some brokers charge commission fees per trade, which isn’t so common. Due to the huge popularity of forex, people are always asking for less expensive services, so many brokers just charge spreads.
However, forex brokers have other sources of income at their disposal. They include:
- Leverage: When forex traders use leverage, they’re taking a loan from the broker. It allows them to multiply the trading volume by tens and hundreds, depending on their margin. These widened positions mean higher income for brokers since they can increase their spreads as much as the leverage.
- Overnight interest rates: Traders with long-term positions either pay or get interest rates based on the difference between the two currencies’ exchange rates. Most of the time, brokers take advantage of these swaps since they’re not symmetrical, meaning the interest rate a trader receives isn’t equal to the rate the other trader pays.
- Commissions on payment processing: Some brokers charge their clients commissions for processing payments when they withdraw or deposit money.
- Signals and education: Reputable brokers sell their educational tools or signals to their clients to help them make more profit.
None of the above income and profit sources depend on the clients’ performance. Brokers earn their share regardless of the traders’ loss or win.
How Do Forex Brokers Lose Money?
When you win a trade, you receive money from the broker, which seems like it pays you with its own money, but that’s not true. When you win, the other end of the trade, your counterparty, has to pay you, not the broker. So, the broker doesn’t lose anything and keeps the commission or the spread, making profits.
Forex brokers don’t lose money because they have fixed income sources, but what about when their clients make a profit? Does it affect the broker’s profits, too?
Forex brokers are intermediaries that work between the traders and liquidity providers like banks. So, logically they shouldn’t have any connections with the trader’s profit or loss. At least, most of them don’t, but some do care about your profit or loss since they’re not mere intermediaries.
For some forex brokers, the income they earn by charging spreads isn’t enough, so they decide to trade against their clients. It’s an unethical way in which they claim to route orders to liquidity providers. Instead of allowing traders to compete with real market participants, these brokers act as the counterparty.
In this case, they get involved in trading and may lose money, but not all brokers trade against their clients.
Different Kinds of Brokers
Forex brokers may lose money depending on what kind of broker they are and how they’re involved in trading.
Market Makers
Market makers are brokers who create liquidity in the market by making transactions with their customers. While market makers are typically large banks and hedge funds, brokers can become market makers and take advantage of the liquidity they create for the market.
They set the bid and ask prices on their platforms where they act as counterparties to their clients. That means they take the opposite side of the trade, and whenever a client takes a position, they take the opposite direction.
They set the exchange rates in a way that’s profitable for them. Plus, their market-making activities have extra income for them through the spreads they charge.
They base their businesses on the fact that a majority of forex beginners lose money. So, by taking the other side of the trade, they can earn considerable profits in addition to spreads and commissions.
However, market-making can cause brokers’ money loss because they trade against their clients and lose when their clients win.
STP Brokers
STP (Straight Through Processing) brokers’ source of income is spreads and markups.
They don’t trade against their clients and pass their trading orders to liquidity providers. Also, they set the prices based on those determined by liquidity providers and may just add a small markup.
Since their clients are trading against other market participants, STP brokers can’t lose any money if these traders win. On the contrary, they would like their clients to win, so they can continue working with them.
True ECN Brokers
Most seasoned and high-volume traders prefer True ECN, which is very similar to the STP model. They display the best bid/ask prices on their systems by collecting prices from different liquidity providers and choosing the most reasonable ones. They don’t manipulate prices since, unlike market makers, they don’t set prices.
Genuine ECN brokers route orders to liquidity providers through electronic systems. They don’t earn their income through spreads. Their spread marks are zero, and they only charge fixed and small amounts of commission for each trade. That’s why many professional traders prefer to work with them. Besides, they don’t have any interest conflict with their clients since they don’t trade against them.
Just like STP brokers, they don’t lose any money when their clients win. On the contrary, they want their clients to succeed and grow their trade size.
However, false ECN brokers may claim to route your orders to liquidity providers but pass them to a market maker broker who trades against you. So, they lose money if you win.
How Much Do Forex Brokers Lose?
So, market makers who trade against you will lose money if you win the game, but how often can this happen? Your broker has access to all your trading data, strategies, and orders. It means they can trade against those clients who they’re sure will lose. They typically trade against beginners to make sure they won’t lose any money.
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Conclusion
Forex brokers earn money through spreads, the difference between the asking and selling price. Although it may sound small, the number of trades amount to enormous profits for brokers. Plus, they have other sources of income, like leverage and interest rates.
Forex brokers don’t lose any money if they earn their income through these venues. However, those who trade against their clients will lose money if the trader wins the trade.
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