Explaining Commissions in Forex Trading

Recent years have seen 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 find. Consider the fact that the Internet was not even invented a few decades ago, and now it is an inconceivable thing not to have an Internet connection. This tells much about its future potential as well, as there are a lot of people in this world who do not yet have access to the Internet. The more people are getting online, the more industries like Forex trading will thrive, and become bigger and bigger in time. Internet access and Forex trading therefore go hand in hand. Forex brokers are advertising everywhere, and this is a powerful statement. From your mail inbox to chat among your favourite sports team, one cannot escape knowing what Forex is, what the risks and the benefits are, and in the end, being drawn to at least test the market to see what it feels like 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 consider that day-to-day economic realities are part of life for 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 obtain than ever. Simply set up a few apps on a smartphone and you’ll be up to  date with everything under the sun, from politics to economics, from monetary policy to economic conferences, etc. And all of these, in the palm of your hand, thanks to the massive embracing of smartphones. What a time to be a Forex broker!

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How Does a Broker Make Money?

All the factors listed above are meant to show the potential of the Forex industry, now and in the foreseeable future. Future industry growth is likely to be exponential, given the two factors most important for making this growth 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 has allowed Forex brokers to link retail traders to the liquidity of the interbank market. This is what a brokerage house does, and this is their 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 organised, a Forex broker has multiple revenue sources:

Spreads. These represent the difference between the ask and the bid prices, and it is different for every currency pair.

Trading. If the broker is organised as a market maker, it will effectively create a market for its customers, and will trade in the opposite direction to its clients’ trade. Chances of succeeding are 80% in favour of the broker.

Commissions. For every transaction, a broker charges a commission. There are a few things important to know about commissions in the Forex market…

What is Commission in Forex Trading?

forex commission When opening a trade, regardless of 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 time of opening of the trade, no matter how long the trade is 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 point, as it has a psychological effect on a trader’s mindset. Let me walk you through the process of profiting in Forex trading…

As mentioned above, the first thing deducted from the trading account is the broker’s commission. This commission can be different based on the type of trading account opened, and on the volume traded. To make a profit, therefore, the position should move in the right direction with the minimum amount taken out for paying the broker’s commission. This is not all, though. Spreads need to be covered as well. If a spread is 1 pip, then to break even the trade needs to go in the right direction for 1 pip plus the commission; then only what’s beyond that represents a profit. In this way, the Forex broker is in a win-win situation: it makes money regardless of whether the trader is making money or not, as its fees (at least the commission) are taken at the opening of the trade.

How Does Commission Vary?

Commission varies with volume. This is something every trader should know, as the volume is an important part in setting the level of commissions that are charged. As a rule of thumb, the higher the volume traded, the higher the commission charged. In other words, if you trade 0.1 lots and your commission is 0.5 USD, on 1.0 lot you can expect the commission to be proportional to that. However, this is not always true, as brokers are in a constant race to provide incentives to attract clients. Even this is not enough, as a broker that wants to make the most out of this business will strive to not only  attract new traders, but also to keep the ones it has as active as possible. There are brokers that lower commissions for each 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 capitalise on it as much as possible.

The conclusion reached by 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 one 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.

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