Explaining Commissions in Forex Trading
Recent years saw Forex trading exploding in popularity, especially among retail traders. There are many reasons for this: more and more people have regular access to the Internet, Forex brokers are advertising everywhere, and the information is easier to reach. Consider the fact that Internet was not even invented a few decades ago and now it is an inconceivable thing not to have an Internet line. This tells much about the future potential as well as there are a lot of people in this world that does not have access to the Internet, yet. The more people are getting online, the more industries like the Forex trading will strive and will become bigger and bigger in time. Therefore, Internet access and Forex trading go hand in hand. Forex brokers are advertising everywhere, and this is a powerful statement. From your mail Inbox to your favorite sports team, one cannot escape knowing what Forex is, what are the risks and benefits, and in the end, will be drawn to at least test the market to see what it feels to be a trader. Even Hollywood embraced the trading mantra in a few successful movies, one of them recently being awarded an Oscar. And if you think that day-to-day economic realities are being part of any regular family, then trading economic differences, or profiting from economic imbalances is something that appeals to human nature. Information needed to trade the Forex market is easier to reach than ever. Simply setting up a few apps on a smartphone and you’ll be up-to-date with everything that goes around the sun, from politics to economics, from monetary policy to economic conferences, etc. And all these, in the palm of your hand, due to the massive embrace of smartphones. What a time to be a Forex broker!
How is a Broker Making Money?
All the factors listed above are meant to show the potential of the Forex industry, now in the foreseeable future. Future industry growth is exponential, if you think of the two factors that make the most for this growth to happen: human nature (the desire to make some money as quick as possible and with as little effort as possible, without having your own boss, taking your own decision, etc.) and future Internet growth. The Internet allowed Forex brokers to link the retail traders to the interbank market liquidity. This is what a brokerage house is doing and this is the revenue stream or at least part of it. As explained in other articles here on the Trading Academy, depending on the way the Forex business is organized, a Forex broker has multiple revenue sources:
Spreads. These represent the difference between the ask and the bid price, and it is different for every currency pair.
Trading. If the broker is organized as a market maker, it will effectively create a market for its customers and will trade in the opposite direction when compared with its client’s trade. Chances to succeed are 80% in favor of the broker.
Commissions. For every transaction, a broker is charging a commission. However, there are a few things to know about commissions in the Forex market.
What is Commission in Forex Trading
When opening a trade, no matter the direction, the first thing that “disappears” from a trading account is the commission the broker charges for that transaction. This is deducted at the opening time of the trade, no matter how long the trade is being kept open. After all, brokers are not running a charity and for the services they provide (giving access to the interbank liquidity market), they charge for a fee. This commission is deducted from the Equity of a trading account, not from the Balance! This is an important thing as it has a psychological effect on a trader’s mind setup. Let me walk you through the process of profiting in Forex trading. From the moment a position is open, the first thing that is deducted from the trading account is the commission the broker charges. This commission can be different based on the trading account opened and on the volume traded. Therefore, to make a profit, the position should move in the right direction with minimum the amount taken for paying the broker’s commission. But this is not all. Spreads need to be covered too. If a spread is one pip, then to break-even the trade needs to go in the right direction for one pip plus the commission. Only what’s beyond represents a profit. In this way, the Forex broker is in a win-win situation: it makes money regardless if the traders are making money or not, as its fees are being taken at the trade’s opening (at least the commission).
How Does Commission Vary?
Commission vary with volume! This is something every trader should know as the volume is an important part in setting commissions that are charged. As a rule of thumb, the bigger the volume traded, the bigger the commission charged. In other words, if you trade 0.1 lots and your commission is 0.5 usd, on a one lot expect the commission to be proportional. However, this is not always true, as brokers are on a constant run for providing incentives to attract clients. And even this is not enough, as a broker that wants to make the most out of this business will strive not only to attract new traders but to make the ones it has as active as possible. Therefore, there are brokers that lower commissions for every transaction the more the traded volume in a trading account grows. In a way, it makes sense as it means the trader is more active on a day to day basis and the broker will earn more from spreads, for example. If the broker is a market maker, it will earn even more from trading in the opposite direction as retail traders face a high probability of losing their first deposit due to the high volatility of the Forex market. Brokers know that and try to capitalize on it as much as possible. The conclusion of this article is that commissions are only normal and they are part of the revenue stream of any Forex broker. Like any other business, Forex brokers need to charge something for their services, and commissions serve this purpose. There is nothing immoral in charging a commission and they can differ from broker to broker and even from a trading account to another. What matters for the Forex trader is to know exactly how to interpret the commission and to incorporate it as a regular cost that comes with any transaction.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market.
- Currency Pairs Types
– Different Currency Pairs, categories, currency pairs with and without U.S. Dollar in their componence.
- What is a Forex Broker and Types of Brokerage houses
– Explaining what a Forex broker is and does, how the business should be organized, and how many types of Forex brokers exist.
- Financial Products to Trade
– Different categories of financial products that a Forex Broker is offering for the retail clients, starting with the classical currency pairs, and continuing with commodities, CFD’s, indexes, etc.
- Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc.
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
Other Educational Materials
- “Multi-agent Forex trading system.” Barbosa, Rui Pedro, and Orlando Belo. In Agent and Multi-agent Technology for Internet and Enterprise Systems, pp. 91-118. Springer Berlin Heidelberg, 2010.
- “Enhancing technical analysis in the Forex market using neural networks.” Chan, Keith CC, and Foo Kean Teong. In Neural Networks, 1995. Proceedings., IEEE International Conference on, vol. 2, pp. 1023-1027. IEEE, 1995.